Persistent rate cuts to save some institutions will weaken the economic system
To the US dollar ‘perma-bulls’ – who having been totally wrong for the last six years but now find new ammunition in the shrinking current account deficit to support their dollar bull case – I also need to point out that there were periods – such as between 1985 and 1991 – during which the dollar tanked while at the same time the current account deficit shrank! This leads me to another point about the world of investments. To make generalisations about what happens to markets, when certain events like wars, favourable earnings announcements, tax and interest rate cuts etc. occur, is dangerous because it all depends on where markets stood before these events happened. The reason why the dollar fell after 1985 despite an improvement in the current account deficit was that it had rallied between 1980 and 1985 and that, in 1985, the dollar had become significantly over-valued against major foreign currencies. This is now certainly not the case since the dollar has declined for six years against the Euro, but what I am driving at is that the investment community still believes that the Fed, by cutting interest rates, can support the housing and stock market. But, as Jeremy Grantham of GMO pointed out, median US home prices compared to median incomes rose between 1998 and 2006 so much above the trend that prices could continue to decline even as the Federal Reserve cuts interest rates.
Also to consider is that unless the Fed buys up mortgages and CDOs it has little control about the pricing of non-government debt (I also doubt that it has much control over the pricing of long term government debt). So, the Fed can cut interest rates, but if credit spreads are widening – as is now the case – rate cuts bring little relief to asset markets and specifically to the housing market because spreads on mortgages are widening. Concerning the Fed and the government buying up mortgages, another point should be considered. When the subprime mess emerged in July, Senator Charles Schumer initially responded to his Wall Street campaign contributors by arguing for rate cuts and for Fannie Mae and Freddie Mac to expand their balance sheets in order to bail out the Street.
But recently Senator Schumer seems to have changed his stance by urging regulators to examine potential risks posed by a sharp increase in lending by the Federal Home Loan Bank of Atlanta to Countrywide Financial Corp., the nations largest mortgage lender. Schumer: “I am concerned that the loans being pledged by Countrywide to secure these advances (borrowings) may pose a risk to the safety and soundness of the FHLB system as a whole” (maybe some shortsellers are also supporting him…).
In essence, what I wish to express is simply that bailing out some rotten financial institutions (I guess all of them are) with monetary measures is far from certain to succeed and - most importantly – such bailouts may lead down the road to a total collapse of the economic system.
For Complete IIPM Article, Click on IIPM Article
Source : IIPM Editorial, 2008
To the US dollar ‘perma-bulls’ – who having been totally wrong for the last six years but now find new ammunition in the shrinking current account deficit to support their dollar bull case – I also need to point out that there were periods – such as between 1985 and 1991 – during which the dollar tanked while at the same time the current account deficit shrank! This leads me to another point about the world of investments. To make generalisations about what happens to markets, when certain events like wars, favourable earnings announcements, tax and interest rate cuts etc. occur, is dangerous because it all depends on where markets stood before these events happened. The reason why the dollar fell after 1985 despite an improvement in the current account deficit was that it had rallied between 1980 and 1985 and that, in 1985, the dollar had become significantly over-valued against major foreign currencies. This is now certainly not the case since the dollar has declined for six years against the Euro, but what I am driving at is that the investment community still believes that the Fed, by cutting interest rates, can support the housing and stock market. But, as Jeremy Grantham of GMO pointed out, median US home prices compared to median incomes rose between 1998 and 2006 so much above the trend that prices could continue to decline even as the Federal Reserve cuts interest rates.
Also to consider is that unless the Fed buys up mortgages and CDOs it has little control about the pricing of non-government debt (I also doubt that it has much control over the pricing of long term government debt). So, the Fed can cut interest rates, but if credit spreads are widening – as is now the case – rate cuts bring little relief to asset markets and specifically to the housing market because spreads on mortgages are widening. Concerning the Fed and the government buying up mortgages, another point should be considered. When the subprime mess emerged in July, Senator Charles Schumer initially responded to his Wall Street campaign contributors by arguing for rate cuts and for Fannie Mae and Freddie Mac to expand their balance sheets in order to bail out the Street.
But recently Senator Schumer seems to have changed his stance by urging regulators to examine potential risks posed by a sharp increase in lending by the Federal Home Loan Bank of Atlanta to Countrywide Financial Corp., the nations largest mortgage lender. Schumer: “I am concerned that the loans being pledged by Countrywide to secure these advances (borrowings) may pose a risk to the safety and soundness of the FHLB system as a whole” (maybe some shortsellers are also supporting him…).
In essence, what I wish to express is simply that bailing out some rotten financial institutions (I guess all of them are) with monetary measures is far from certain to succeed and - most importantly – such bailouts may lead down the road to a total collapse of the economic system.
For Complete IIPM Article, Click on IIPM Article
Source : IIPM Editorial, 2008
An IIPM and Professor Arindam Chaudhuri (Renowned Management Guru and Economist) Initiative
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