The Fed and Your Interest

There is a lot of cynicism about the role of the Federal Reserve and its effect on the average person. There are some who believe that it is a caser of very wealthy bankers making decisions that affect people whom they neither know nor necessarily understand. The Fed looks at statistics not people.

What would be important to me would be the economic factors that might precipitate further rate increases by the Fed. I normally would have a choice between a fixed rate mortgage and a flexible rate one. If indicators tend to see that the Fed is attempting to stem inflation by raising interest rates, then a fixed rate mortgage would be best. I know, therefore, what my monthly costs are for twenty or thirty years, whatever the length of the mortgage I arrange.

Woodruff (2006) considers three forces as key in determining whether interest rates go up, down, or stay the same. The first one is ¡§The amount of money saved ion the economy, mostly households¡¨ (Woodruff 1). Whether we are spending more, or just saving less, the average American family has lost a lot of its savings since 1970: ¡§As of December 2005, savings were at an all-time record low of negative 0.7 percent !! Consumers spent $42 billion more than they earned in 2005, the biggest dip in savings since record-keeping began in 1929 (Bloomberg 1/30/06). $985 Billion in savings missing¡¨ (Hedges 6). This does not bode well for the overall economy.

It might be worthwhile for me to look at the weekly Department of Labor employment reports. ¡§This is one of the anomalies of economics. In this theory, low employment often leads to higher inflation¡¨ (Woodruff 2). There is, of course, more than statistics to double-check. As Amos points out: ¡§¡K.it¡¦s not just what you own that makes you wealthy, it¡¦s the difference between what you own and what you owe¡¨ (Amos 1). That is a cautionary statement. One needs to understand not merely the risks of a mortgage (that is, taking out a huge loan on your house) but also the problem of being able to continue to pay principal and interest over the years. There is risk involved, of course. So, one really needs to do more than check real estate prices and the financial pages of the local newspaper or The Wall Street Journal. According to Amos, one needs to be aware of what he considers ¡§unnewsworthy financial stuff¡¨ (Amos 3). Among them might be the Consumer Price Index, which, according to Woodruff ¡§is the most commonly cited measurement of inflation¡¨ (Woodruff 2). Even though, as Woodruff claims, the CPI has not been considered as accurate as it might be, still it measures the trends of inflation better than probably anything else.

While the Bible may be cautious and exclaim that ¡§the love of money is the root of all evil¡¨ today money and its desirability lies at the roots of Capitalism. At least in the U.S. we all want to ¡§own¡¨ something- a home, a business, a car, a nice kitchen and appliances, a Plasma TV. Whatever it is, the fact that credit seems to be so easy to obtain, too many of us- myself included- are apt to ¡§put it on a credit card.¡¨ Somehow, it seems so much easier to just hand someone a piece of plastic than to dig in the wallet for cash, or to write a check. What happens, however, is that every time the Fed makes a move to stem inflation (or what they consider might continue to be inflationary) and raises the prime rate for banks, the amount we have to pay the credit card companies for letting us borrow their funds goes up. Of course, banks love the idea of more and more people borrowing their funds, because they earn money on the interest they charge- which is considerably higher than the Fed¡¦s prime rate determination.

Perhaps it is simplistic to accuse the governors of the Fed as holding my purse strings- permitting me to buy a house or appliances or a car on credit without really caring whether or how I can pay for those purchases. The problem as Taylor (2001) indicates is that even a liberal banker, once appointed to the Fed, tends to become conservative. She quotes one member of the Fed, once considered to be ¡§soft on inflation¡¨: ¡§You are sitting here as the only bulwark against inflation¡¨ (Taylor 7).

What can worry an individual who is not well versed on the Fed or economic indicators, someone who does not peruse the financial pages regularly is the constant talk about ¡§inflation.¡¨ Most of us tend to be ignorant where inflation starts or where it stops. We often hear and red about the so-called ¡§cost of living¡¨ because many salaries are based on that figure, especially seniors who depend on their monthly social security checks. It is this concern- or lack thereof-0 about inflation and the future actions of the Fed that can really distract a potential home-owner. Today, for example, the real estate market is booming. There are more million-dollar homes which were built and sold for far less just a few short years ago. But, how can the Fed tell me, a potential home buyer, whether this market is continuing to rise in the foreseeable future, or whether this ¡§real estate bubble¡¨ will burst one day soon.

In a report published April 20, in The Christian Science Monitor, It now appears the Federal Reserve is nearing the end of its long program of raising interest rates. Most economists now believe next month will be the final quarter-point hike:

¡§For millions of Americans it will be a welcome hiatus:

"h About 25 percent of all Americans now have a home equity loan.

The loans have been used to buy cars, boats, and more houses.

"h The interest rate on some 11 million adjustable rate mortgages (ARMs)

will be resetting at a higher rate over the next two years.

"h As of the end of 2004, CardWeb.com estimates the average credit

card debt per household was $9,312. The interest rate on that debt has been

steadily rising.

"h The interest rate for small business loans will top out at close to 8 percent ¡X

still a low rate historically¡¨ (Scherer and Bradley 1).

It is worth reiterating Amos¡¦ concern that it is not what you own that is vital but how much you owe. That $9,000+ figure of household debt is alarming, especially to those like myself who will increase my personal debt by hundred of thousands in mortgages and other purchases for a new home.

Again, a personal concern is the seeming lack of concern about the average person by the Fed. They tend to absorb the big picture, and the trickle down effect is not really their problem. Inflation does not come through personal experiences, but by labor statistics, CPI, the demand for notes or loans, etc. As the Fed raises rates, however, it does cause problems down the line. ¡§Mortgage applications have been declining as interest rates move up, leaving banks to sing the mortgage blues despite robust business conditions overall. With the fed funds rate up near 5%, the cost of borrowing for banks has been increasing. As the 10-year Treasury note yield rises, mortgage defaults are more likely in another blow to banks¡¨ (Gelsi 1).

Again, looking at Taylor¡¦s Chapter 8, one can find that ¡§The central bank provides the critical missing link by protecting the banking system from liquidity and solvency crises¡¨ (Taylor 8). Obviously, the many bank failures during the Great Depression has established the Fed as that ¡§bulwark¡¨ mentioned earlier. But, my personal concern is not about the bank¡¦s financial liquidity, but mine. What is the Fed doing actively to support my ability to purchase and pay for a house with a mortgage that is failure and equitable? One might even accuse the Fed of not being consumer-friendly. If rates are not going to go up in the future, then a fixed-rate mortgage might be a good investment. But, if inflation reverses and the Fed again lowers the prime, should I consider an adjustable rate mortgage? It is continuing to be a struggle to understand and deal with future possibilities.

WORKS CITED:

Amos, O. ¡§Borrowing through financial markets¡¨ A Pedestrian¡¦s Guide to Economy (Aug. 2005 www.amosweb.com/pdg

Amos, O. ¡§Creating Wealth¡¨ A Pedestrian¡¦s Guide to Economy (Aug. 2005 www.amosweb.com/pdg

Gelsi, Steve: ¡§Mortgages bite into bank profits¡¨ Market Watch, April 20, 2006.

Hedges, Michael: ¡§Family Income Report¡¨ mwhodges.home.att.net/family_a.htm

Scherer, Ron and Bradley, Matt: ¡§Many Helped if Fed Stops Raising Rates¡¨ The Christian Science Monitor, April 20, 2006

Taylor, K.S. ¡§Chapter 8: Money: From barter to banks¡¨ Human Society and the Global Economy Bellevue WA: Bellevue Community College Aug, 2005

Woodruff, Tom: ¡§A Borrower¡¦s guide to forecasting interest rates¡¨ moneycentral.msn.com/content/investing/realestate/p39219.asp