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Why Higher Interest Rates is a Bad Move for the FED and the Economy Right Now

August 13th, 2009
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Why Higher Interest Rates is a Bad Move for the FED and the Economy Right Now

original article written by Net Advisor™

WASHINGTON DC. The FED made a big error (again) starting in the spring of 2004 when it began raising interest rates (Fed Fund Rate “FFR”) due to “inflation concerns.” They continued to raise rates through 06-29-2006 with a total increase of 425% in the Fed Funds Rate.

Banks increased rates as the FED increased rates on banks. And no one thought this could impact an adjustable rate mortgage? A few people did – (Christopher Thornberg), (Peter Shiff), (John Paulson – the hedge fund king who best figured out to make money on this future problem), a handful of others, and yes, yours truly.

Previous Fed Chairman Alan Greenspan raised rates from 1998-2000. That not only helped crash the .com market, but contributed to the recession of 2000-2002.

The FED also erred in 1994 when it abruptly raised interest rates. One could go back in history and find that time timing of rising rates does not stimulate the economy.

The FED raised rates 17 times from 2004 to 2006.The stock market was not excited about the FED pushing rates higher.

[1] The FED KNEW back in 2006, that continuing to raise rates was a bad idea.

“Federal Reserve Chairman Ben S. Bernanke, laying the groundwork for a pause in interest-rate increases, said policy makers must be wary of lifting borrowing costs too high.”

— Source: Bloomberg, 07-19-2006

We’ll the FED had no clue (back in 2004-2006) about what impact 17 rate hikes could do to the housing market; and what a plunge in real estate and stocks prices could do to the economy. Continuing:

“(FED Chairman) Bernanke said the economy is in a period of transition as consumer spending slackens, though he doesn’t foresee a recession.”

— Source: Bloomberg, 07-19-2006

CNBC‘s James Cramer clearly called it when Cramer hammered the FED (on 08-03-2007) for being “asleep” at the economic wheel (see video @1:40 min). (Additional video and information posted 08-07-2007).

The FED finally woke up and realized there were big problems in the economy that was brewing since 2006. By January 22, 2008, the FED took evasive action and lowered rates 3/4 of 1 point (75 basis points or 0.75%) in an “emergency move.” This was the biggest rate drop since the recession of 1981-82 when the FED tried to stop inflation by hiking rates to 20% (source).

I argue that the stock market figured that this was an unexpected and desperate (but required) move by the FED. Wall Street reacted (arguably the correct move) to the FED’s panicking, and initially sold off 400 points right after the unexpected FED rate cut. Wall Street was starting to figure out that the economy was going to get worse in 2008.

The FED had been lowering interest rates since September 18, 2007, but it was too was too late to try and stop the biggest economic cruise ship (USA) from hitting an iceberg (major recession). (My Yahoo comments back in 2007 on the FED’s rate cut.)

[2] Here We Go Again?

It is expected that the FED may raise rates again, which could be as early as late fall 2009 to a midpoint of winter 2010 to as late as summer 2010. I would argue that the FED should delay any decision on rates until no sooner than summer 2011 to as late as 2015.

When the FED moves to up rates, it won’t be a one-time rate increase. It is usually followed by a series of rates increases. I argue that it is possible the FED maybe even have 8-12+ rate increases.

Twelve FED rate increase at 1/4 point each would be a 3.00% to 3.25% (12x .25) Fed Funds Rate, up from current 0 to 1/4 point rate. This would put us back to a Fed Funds target rate in January 2008.
As the FED raises rates, banks will follow by the same increase, if not more. The cost of borrowing thus would go up with each FED rate increase.

The current Prime Rate (interest rate banks charge to their best customers) as of 12-16-2008 is 3.25%. If we add 3.00% to that number to account for the FED rate increases over say the next 2 years, we are looking at a 6.25% Prime Rate; that’s a 92% increase over current interest rates. Ouch!

Sure, some will argue that 6.25% is still below the historical average rate, but we are not sitting in a “normal recession” either.

So, I repeat back like a broken record since 2004 upon seeing the first FED rate hike in 4 years, does anyone think that higher rates will have a negative impact on say… adjustable rate mortgages, commercial mortgages, mortgage refinancing, cost of obtaining loans, interest charges on credit cards, interest charged on auto loans or financing the National Debt? Of course not; all those industries are booming again and we can afford to raise interest rates, right?

[3] Q&A.

Question: So why is the FED considering raising rates again?

Answer: Future inflation concerns.

Question: Wasn’t this the same argument used in 1994, 1998-2000, and 2004-2006 and many times in US history?

Answer: Yes.

Question: What happened after those rate increases?

Answer: Recession followed.

Question: So why is the FED going to raise rates again?

Answer: Future inflation concerns.

[4] Future Issue.

Rate increases will accelerate the interest cost of the National Debt, and long term this is going to be a major issue. How big? Technically this could be a bigger issue than the Great Depression and make the “Credit Crisis” of 2007-2009 look like a joy ride at Disneyland.

This may not happen for several years in the future, up to 40 years, but it is something that must be dealt with. Congress must get control on government spending and spend within their means and not create deficits year after year, after year. It would not make financial sense for the FED to raise the cost on US Debt when that rate needs to stay low to keep interest on the debt low, stabilize consumers financially, and help grow the economy.

So why would the FED increase rates if the end result will be a risk to the real estate market, risk to consumers, and increase risk to the economy – again. Good question.


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