Memo to Bernanke: Enough with the Rate Cuts, Already!

[Crewleader]

Memo to Bernanke: Enough with the Rate Cuts, Already!

by Mike Whitney / April 24th, 2008

Last week’s stock market blowout added more than 4 per cent to the Dow Jones Industrials, but it had no affect on Libor rates. Libor rose steadily from Tuesday through Friday signaling more troubles in the banking system. Libor, which means London Interbank-Offered Rate, is the rate that banks charge each other for loans. It has a dramatic effect on nearly every area of investment. When the rate soars, as it did last week, it means that the banks are either too weak financially to lend to each other or too worried about the ability of the other bank to repay them back. Either way, it puts a crimp in lending. Banks serve as the transmission point for credit to the broader economy via business and consumer loans. When they’re bogged down by their own bad investments or when risks increase, rates go up, lending slows, business activity decreases and GDP shrinks. It’s a vicious circle.

The sudden surge in stocks is not a sign that things are back to normal; far from it. If anything, things are worse than ever. Credit remains unusually tight despite Bernanke’s cuts to the Fed Funds rate or the creation of various “auction facilities” that remove mortgage-backed securities (MBS) from banks balance sheets. Businesses and consumers are still having a hard time getting funding, which means that the velocity of money in the financial system is decelerating rapidly and this increases the likelihood of a system-wide freeze-up. Libor is just the flashing red light.

A rise in Libor adds billions in additional interest payments for homeowners, businesses and other borrowers. According to the Wall Street Journal:

http://www.dissidentvoice.org/2008/04/memo-to-bernanke-enough-with-the-rate-cuts-already/

[AdHocSolver]

1. Artificially low interest rates enabled the economic debacle we are in and they won't fix it.

Some economist (Keynes??) wrote during the Great Depression of the 1930's that the interest rates could drop to zero percent and it won't help the economy one bit if there is NO demand.

What was the purpose of the Fed's (under Greenspan) maintaining artificially low interest rates?

There were two dynamics at work. One was to lower the interest paid to depositors on savings accounts, CD's and the like to "encourage" them to take their life savings out of insured accounts and gamble it away on the stock market. Having the middle class throw a lot of money at the stock market (increased demand) drove the stock prices up and made the wealthy insiders even wealthier with their bonuses and perks in the form of stock options. A bonus for the wealthy was that, when the stock prices dropped, as they would eventually, these middle class investors would be holding "worthless" paper for which they would never have to be reimbursed, since the middle class accepted the "risk" when they transferred their life savings from insured accounts to "you take your chances" corporate stocks. (That is, the money went in one direction only, no value was returned.)

Besides gambling in the stock market, the low Fed rates made possible Adjustable Rate Mortgages and the real estate boom. Such low rates "encouraged" people to take on more debt than they could afford and drove house prices up. "At these low interest rates," thought Mr. and Ms. home buyer, "we can afford the payments on this more expensive house." The real estate companies and mortgage companies made out like bandits on commissions and fees.

The other boon of low interest rates to a bank's bottom line is the spread between the low interest that they pay depositors and the much higher rates that the bank charges for loans and credit card balances. Depositors should have been paid much higher interest for the use of their deposits since many banks were charging credit card customers upwards of fifteen percent on credit card balances.

The artificially maintained low interest rates were designed to provide huge profits for banks, stock brokerage firms, and corporations. It amounts to a swindle of gigantic proportions of the American middle class, and promoted what is likely the biggest transfer of wealth upward in U.S. history.

Add to this the huge trade deficits caused by the offshoring of jobs, the huge boondoggles, corporate welfare, tax cuts for the rich, and the Iraq war and continued occupation, and this country is headed toward economic collapse.

[Yavin4]

2. You Are 100% Correct

Terrific analysis. However, you forgot one last piece. Low interst rates also has a strong political effect. When borrowing is cheaper, it brings about asset inflation. The working class masses can feel like they are indeed middle class because they buy huge homes, purchase big cars and other toys like TVs. Hence, they're less likely to vote for Democratic candidates who want more social spending on things like healthcare and education.