Sunday, September 23, 2007

Conspiracists Against The Rate Cut

My favorite conspiracy nut friend has been sending me a steady stream of articles via IM about why she thinks that that the recent decision by the Federal Reserve to cut the Fed Funds rate by a half-point was a really bad idea.

Actually, there are some side effects to this rate cut that do deserve some discussion.

Basically, the mechanism by which the Fed lowers interest rates is by flooding the short-term credit market with more money. Any time you inject more money into a system, it tends to cause inflation. Basically it causes anything denominated in US Dollars to increase value in dollars, and causes the value of the dollar itself to decline, particularly in relationship to other currencies. For instance, for the first time in many years, the Canadian dollar is approaching equity with its US counterpart.

But, despite the rate cut, Fed Chairman Ben Bernanke is still warning of subprime defaults surging in the coming months and actually encouraging "lenders and loan servicers to identify and contact borrowers who, with counselling and possible loan modifications, may be able to avoid entering delinquency or foreclosure."


As much as people hate to think about it, there may ultimately be no choice but a massive government bail-out on this one.

The Fed Funds rate cut is good, but it is only a band-aid. It helps with adjustable rate mortgages, but it also fuels the inflation fire. It basically floods money into the system indiscriminately.

What the Fed needs to do is actually lend money DIRECTLY to people with adjustable rate mortgages. They need to set up 30-year fixed-rate loans at about 6.5% to anyone with a currently variable mortgage.

And of course going forward they need to set it up so that someone applying for a variable rate mortgage has the income to cover the payments on that mortgage if it adjusts to its MAXIMUM rate.

This, ulimtately, is the ONLY way to stop the chain reaction of chaos that is almost certain to continue under present conditions ...

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