Will the Fed cut interest rates to respond to the subprime mortgage crisis?
Let me be very clear: there is no true crisis related to subprime mortgages, nor will there be. At worst, you could call the situation a mini-crisis, which has been caused by far too much mindless chattering, inflamed by a bit of yellow journalism as well.
So, there is no crisis to be dealt with.
Hence, there is nothing for the Fed to do other than to repeat the mantra "There is no crisis."
Cutting rates would not make sense since it was low rates that kicked off the subprime lending frenzy in the first place.
Most importantly, there is already far too much liquidity sloshing around in our financial system for there to be any need for the Fed to add any more.
In short, the Fed is not going to cut interest rates to cope with the so-called subprime mortgage crisis.
Furthermore, fed funds futures are not forecasting a rate cut this month or in may.
posted by Jack Krupansky @ 1:32 AM
2 Comments
2 Comments:
"Cutting rates would not make sense since it was low rates that kicked off the subprime lending frenzy in the first place"
Jack, You pen a good article here about why the bark may well be worse than the bite but I will take "technical issue" with the above statement.
The subprime frenzy was fueled by:
(1) stated income abuse
(2) lower downpayment requirements
(3) relaxed lender guidelines due to Wall Street's appetite for mortgage securities.
Lower rates had VERY little to play in the frenzy. In fact, when a tightening credit cycle happens as quickly as this, it is advisable for the Fed to ease quickly to insure liquidity (READ: Asian crisis of 1998).
I don't mean to be pedantic. You are the first "blogger" to not equate this collapse to the Armageddon so I applaud your insight.
I'll stick with my statement but clarify what I really meant.
At the end of the day, the main difference between a true "subprime" mortgage and a non-subprime mortgage is that the subprime has a higher interest rate (or "spread") above a "prime" mortgage rate. The only way a subprime rate can be low is if the comparable prime mortgage rate is even lower. Ultra-low Fed rates fueled the overall mortgage boom back in 2002-2005. There were other global factors as well that helped to push long-term interest rates down, but the Fed was factor #1, coupled with the Fed keeping inflation expectations reasonably low.
Low rates forced investors to "chase yield", fueling the frenzy for mortgage-backed securities (MBS) which was mostly prime plus some sub-prime.
Slowing demand (relatively speaking) for prime mortgages fueled the demand (by Wall Street) for subprime mortgages.
A relative weakening of actual demand from "qualified borrowers" for subprimes, coupled with that "insatiable" demand for subprime mortgages by Wall Street finally led to lenders dramatically lowering standards to keep the mortgages flowing, and opening the door wide open to the abuses.
So, maybe it is merely a matter of how you define "frenzy" and what stage you define as when the frenzy had reached some threshold level. I'm simply referring to the starting point of the whole housing frenzy, of which subprimes were a sub-frenzy.
Certainly the "hyper"-frenzy came with the lowered standards, but you coulnd't have had hyper-frenzy without rates being relatively low to begin with.
Personally, I would classify the aggressive marketing of ARMs as part of the "frenzy" even though the later abuses weren't yet there in force. The subprime ARMs were a lesser form of abuse of the borrower, but still a concern, even relative to the actual fraud of the later stages of the frenzy with undocumented income.
The availability of truly massive amounts of capital, fueled by low Fed rates, incited far too much greed, and that greed led to the subprime abuses.
As far as liquidity, its all still here with us, just shifted around a bit. The fact that Freddie Mac reported average 15-year fixed mortgage rates down to 5.86% is a sterling indicator of how much liquidity is still available for mortgages despite the "crisis".
The current episode is so very unlike 1998, when liquidity was a real issue.
Rest assured, that regardless what people say in the media about the prospects of the Fed doing something with rates, there are plenty of smart people on Wall Street who do know how to judge the Fed well and fed funds futures contract prices show you how they are betting, and right now (next few weeks or month) the odds of a Fed rate cut are essentially zero (2% or less), according to the pricing of those futures contracts.
Hope that clarifies a bit.
-- Jack Krupansky
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