Ready to Refinance?

Uncle Ben is prepin' up for the deepest interest rate cut in a generation.

Traders predict the Federal Open Market Committee, meeting today in Washington, will lower the overnight lending rate by a full percentage point or more, based on futures prices in Chicago. That would be the biggest reduction since 1984, when Paul Volcker led the central bank, and would bring the benchmark rate down to 2 percent.

``The Fed will be extremely hesitant to disappoint the markets,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets Inc. and a former member of the Richmond Fed staff, who predicts a full percentage-point cut. ``Things are still very fragile. We are in a situation where credit tightening has started to feed on itself, and it has real economic implications.''

The drop in the fed fund rate should cause a reduction in other lending rates, which may position one well to refinance his or her mortgage. This may not be enough to ward off the spectre of a US recession, but it could be advantageous to us little people in the short-term. But how about the long-term?

What will happen?

With a long-term perspective, Robert P. Murphy and Lee Hoskins note:

The Fed needs to quit chasing declining GDP growth and instead focus on curbing inflation and anchoring inflation expectations.

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...the Fed has slashed its target rate 2.25 percentage points since September, and has engaged in all manner of novel auction schemes to bolster liquidity, particularly among those holding the bag on soured mortgages. Yet despite momentary blips upward, the stock market and the overall economy continue to slide. Even as the Fed's actions pushed many short-term interest rates below the inflation rate, fixed mortgage rates have begun rising. As inflation expectations gather steam, the Fed will find itself painted into an ever-shrinking corner.

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The Fed has abandoned the one thing it can truly control--the long-run increase in price levels--in a self-defeating attempt to keep the economy growing.

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The Fed should commit to long-term price stability, and it needs to back up that commitment with action. Recessions will always be with us, but they will be shallow and short when the Fed keeps inflation low and evenly paced. If the Fed continues cutting rates, we will simply get the worst of both worlds: prolonged recession and excessive inflation.

While the short-term may be advantageous, we have to consider the long-run repercussions of the Fed's actions. Saving a point or two on a mortgage can be thrilling, but the long-term view makes one think twice about the whole economic picture.

Uncle Ben, what are you doing?

UPDATE...

Apparently I'm mistaken, still stuck on the old paradigm...

Jon Markman explains why the Fed's rate cuts won't help you:

It seems odd, but these are extraordinary times. Normally, when the Federal Reserve cuts the rate at which it lends money to U.S. banks, those banks in turn cut the rates at which they lend money to citizens and companies for personal and commercial use. Simple enough. Yet in the past few months, banks have made three important changes in their usual practice:

• They have not been passing all of their interest-rate savings to customers.


• They have restricted lending only to most creditworthy, documented applicants.


• They have cut the total amount they're willing to lend.

WHY?

Banks are taking these seemingly perverse steps in an effort to reverse the effects of the massive losses they have withstood for lending too broadly to consumers and companies with lousy credit over the past five years.

They're pulling a big 180, which is as confusing as it is disheartening. Rather than providing funds to prospective home buyers and business people with legitimate needs for moving into larger homes or expanding factory lines, records show the banks are hoarding the low-cost money they're borrowing from the Fed and investing it in Treasury bonds paying higher interest yields. They're then pocketing the windfall profits to repair their own ravaged balance sheets.

As if that's not bad enough, the Fed's swiftly conceived, unprecedented course of action harms the public in three other ways:

• It boosts inflation by lifting the total number of dollars in circulation.


• It undercuts the attractiveness of the U.S. dollar, which leads to higher food, energy and gold prices.


• It cuts the yields of dividend-paying investments such as government bonds upon which retirees depend for steady income.

In other words, the Fed action helps imprudent bankers dig out of a hole by putting prudent citizens and foreigners in one. This gives big financial businesses a shot at staving off disaster at the risk of cutting the spending and earning power of everyone else.

God help us.

Fed cuts rates by three-quarters of a point


Fed cuts rates by 3/4 of a point2:20pm: Central bank lowers key rate to lower borrowing costs for consumers, businesses, as it risks lower dollar in effort to ward off recession. more

Read the Fed's statement
Europe holds tight