

Fed cuts interest rates to 3.5% - blackswan
http://news.bbc.co.uk/2/hi/business/7202645.stm

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chime
Either I'm stupid or Fed is amazingly stupid. I'm not sure which one is the
case though I really hope it's me.

The reckless mortgage boom and the ensuing crisis was caused when the Fed cut
rates to avoid recession and made borrowing so easy. Now to fix the mess
caused by lowering interest rates, they're trying to lower interest rates?

If you're bleeding from your wrists because you slashed your wrist with a
knife, you don't slash your arm higher up to stop the bleeding from the
wrists. Well true, it does stop you from bleeding from the wrists but now
you're bleeding from the upper arm! Of course, you can stop the bleeding there
by slitting your biceps. Pretty soon you're going to have to cut off your arm
to "stop" the bleeding.

How about they just let there be a recession so the organizations that were
investing poorly lose money and go out of business while the investors who
were smart and focussed stay in the game?

~~~
comatose_kid
I don't agree. I think the Fed should have lowered rates earlier. Lower rates
lead to a better lending environment which leads to economic growth. If the
Fed had cut more drastically earlier, we wouldn't be worried about a recession
right now. And I'll bet the dollar would be even higher, since the world likes
investing in currencies that are backed by a strong economy.

There is no need to go through a recession just to make the 'organizations
that were investing poorly' pay. The market won't discriminate to that degree
(ie, good investments that have nothing to do with housing and have wonderful
balance sheets like Apple will also go down).

If you're going to use medical analogies, I'd say that avoiding a rate cut to
punish the 'bad' companies is like committing suicide to alleviate an upset
stomach....

Anyways, the problems weren't caused by lower rates alone - banks weren't very
good at evaluating the risk profile of the people they were loaning money to.
And repackaging mortgages to sell them to the 'bigger fool' gave them little
incentive to be more vigilant - in fact, it rewarded aggressive lending
practices .

I think lenders are now more aware of the problems with this line of thought,
which is why they are so reticent to lend now.

Hopefully the Fed will cut again at their next meeting.

~~~
Dauntless
You clearly don't know what hyperinflation does to an economy. It's not like
lowering rates is a silver bullet to economic growth. Lowering rates
compromises long term growth for short term growth. "Hopefully the Fed will
cut again at their next meeting." ... ahhh, forget about it.

~~~
comatose_kid
You're clearly assuming that lowering interest rates will cause
hyperinflation. Back that up instead of talking down to me.

Explain how hyperinflation will occur when what is typically a person's most
valuable asset (home) decreases in price. Explain how hyperinflation will
occur if we're in for a recession and the associated job losses.

Lowering rates does not sacrifice long term growth. Rates were drastically
lowered in 91 and 82 (83?) as well, and that didn't exactly negatively impact
long term growth.

I'm serious, and I'd appreciate something concrete to help me understand why
my viewpoint is incorrect.

~~~
david927
By lowering the prime interest rate, they are making it easier to borrow
dollars, which lowers the dollar's value, which causes price inflation.

If you have a strong dollar, you can lower rates. But the dollar is at an all-
time low, so then to have a 75bps drop hit it, the result is essentially
pushing it towards hyperinflation.

~~~
vitaminj
Actually in classical macro theory, lower interest rates (which amounts to the
Fed increasing the money supply) leads to greater investment due to cheaper
credit, leading to higher output growth in the short run and subsequently
lower unemployment. With higher demand for their labour, workers will ask for
more cash leading to wage inflation. And because wages are a major input into
goods and services, higher wages will cause firms to raise prices - hence
price inflation.

That's the theory anyway. There's been alot of criticism on it, but
macroeconomists in reserve banks around the world tend to subscribe to this
theory when using interest rates to control growth and inflation.

The relationship between interest rates and the dollar is via the interest
rate parity condition (<http://en.wikipedia.org/wiki/Interest_rate_parity>),
which is a feature of open markets (to take into account arbitrage
opportunities). Lowering the value of the dollar doesn't cause inflation
directly. I suppose it does so indirectly by stimulating exports and raising
output growth, which leads to lower unemployment and so on.

Lowering interest rates will likely increase inflation, but hyperinflation is
a bit rich. Current US inflation is 4%, which is high, but a long way from
hyperinflation (see zimbabwe - 1000%+).

~~~
david927
You could have just said:

> Actually in classical macro theory, lower interest rates (which amounts to
> the Fed increasing the money supply) ... hence price inflation.

If the money supply is increased (more dollar bills are printed), you'll need
more to pay for the same thing: and that is directly price inflation. You can
ignore the expected effects in the middle. (In fact, there's no direct
correlation to cheaper credit and greater investment.)

4% is stated core inflation. The true inflation number is much higher, but
it's hard to know because there's a lot of effort put into diminishing it, for
obvious reasons. Sure we're not in hyperinflation yet, but the idea is that it
could get there quickly. While it seems impossible from the comfort of growing
up in the second half of the 20th century, America is in much more trouble
than it realizes.

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Novash
Ok, call me stupid. I am a coder, not an accountant. Besides, I am Brazilian
so I don't even know how american economy works exactly. Can someone explain
what's this fuss is all about in good layman terms?

~~~
cratuki
I'm a coder non-economist also, but have been look at this for a few months
and will take a shot at explaining it.

The way the fed aim to control interest rates is via the amount of money that
they issue into circulation. The problem is that when the government puts more
money into circulation it waters down the value of the money already in
circulation, thereby encouraging consumption and some types of investment, and
punishes saving by putting money in the bank. You buy goods so that you have
physicals and not money which is losing value. Thus, it's quite controversial
when a government institution participates in this way in that it is
effectively directing the market.

"Austrians School" economists get particularly upset by this sort of practice
where a government manipulates the market in order to steer to an outcome
because one of the tenants of that way of looking at the world is that free
markets lead to better outcomes than when governments try to manage economies.
Frederick Hayek labelled the confidence of being able to second guess the
market and manage it towards a desirable outcome "the fatal conceit" and
there's a great book about it. Hence the way that Ron Paul (also an Austrian)
gets stuck into the federal reserve at each opportunity, particularly over
stuff like rate rises.

The other aspect, and the reason that the current instability is unsettling
and that governments and institutions are doing a lot more than usual to prop
things up is structural.

First - let's look at an example of a crash that isn't structural. Back when
the dot come crash happened it was pretty simple: a whole lot of people had
invested in stock, the market changed its confidence in that stock, a whole
lot of people lost money. The banks took money in and paid it out and
everything was fine. The market functioned. September 11 was the same even
though trading floors had been taken out. None of these things changed the
nature of market dynamics.

Now one that has been structural: Friedman blames the depression on the US
Federal Reserve for failing to honour its responsibility to supply liquidity
to banks who were short of it (as the UK government have recently done to try
and get Northern Rock through).

The problem with the sub-prime situation though is that the rot is to do with
the core responsibility of banks: managing risk. Banks take money in and loan
it out, and make judgements about repayment risk to make sure that they make a
net profit. But the change to banking culture that led to the sub-prime crisis
was this: it became popular to package debts in certain combinations and sell
them off to a far greater extent than had ever been done before. So you could
buy certain packages of debt that had been guaranteed to fit a certain level
of exposure. Basically this represents large scale outsourcing of bank's core
business. (That's a nasty way to put it though, because in fact when you loan
money in any sense you're outsourcing risk to some extent and this has always
happened, just not to the same extent.)

The sub-prime crisis over the last year has given everyone in the banks the
jitters because they've lost some confidence in the risk assessments made by
banks they have previously exchanged risk with. Worse, they're not so sure
about how much other banks know about their own risk and whether they're being
entirely square with the market about it. Thus they start getting very more
edgy than usual about short-term loans because the other party might not know
what its position is or it might become susceptible to slight changes in the
economy. And now the US (where most of the bad exposure was) is slipping into
recession... meaning more people will fail on their home loans...

The real problem from subprime is that if the banks stop dealing with one
another, you can be certain that economic activity will decline further. This
will cause less people will be able to pay their mortgages. This will cause
banks who are currently on the edge to slip. In other words - ouch. If there
is a crash resulting from lack of confidence it will eclipse the actual value
of money lost due to dodgy loans.

Thus, from a certain perspective there is some sense in 'the people' via their
elected institutions throwing money at this problem, because even though we're
not individually responsible for causing it, it's possible we may be able to
buy our way out of it and come out ahead of where we'd be if we had to suffer
the consequences of a banking collapse. The problem is - if it is inevitable,
then we will have spent a whole lot of money for no good cause.

I can't help but think that monetarists have become too clever by half, and
that it would be preferable if we were to all just resign ourselves to having
ten year economic cycles. Things are much more highly geared now as a result
of a prolonged period of good times and if it gets really nasty there will be
a lasting effect in people's psyches that actually limits our ability to get
out of it (much as there was in the depression where people saved money even
when it was in their interest to participate in some consumption). But time
will tell. :)

~~~
shimon
This is a pretty good explanation of the situation. At least as far as I can
tell, being a coder who's recently tried to learn a lot about macroeconomics.

One detail that could use correction:

"The way the fed aim to control interest rates is via the amount of money that
they issue into circulation."

It's kinda the opposite, actually. When you hear that the Fed's cut its
interest rate, that means they've reduced what's called the Discount Rate --
the rate at which the Fed makes overnight loans to major banks. If you're a
major bank, and you need some cash, you can get these overnight loans from the
Fed or you can take money from other places, and your decision is probably
based on whatever's cheapest. Since the Fed is always there as a last resort
lender for banks, interest rates for other loans between banks and from banks
to businesses will generally reflect changes to the Fed Discount rate. That's
how the Fed rate has a rippling influence on liquidity supply throughout the
banking industry.

Of course, the thing that's special about the Fed is that, unlike typical
banks, it's not loaning out assets it has on deposit. It's creating new money
when someone takes out a Fed loan, and it's destroying that money when the
loan is repaid. Since this increases the money supply, it risks creating
inflation if the economy isn't growing proportionately. High inflation is bad
because it encourages spending your money now rather than investing it, and
long-term growth depends on a lot of investments -- education, equipment,
research, etc.

~~~
albertcardona
"Banking industry" is an insult to those who actually produce goods. Banks
should be known as "facilitators", when doing their job properly, and all
sorts of bad words when they don't -which is frequently, unfortunately.

~~~
cratuki
> "Banking industry" is an insult to those who actually > produce goods.

What do you think should be a use of industry? Is it OK to say "transport
industry" despite the fact that what they do is a service?

Banks produce value through strategic use of risk calculation. They take in
$100 and then lend out $90 for further wealth creation, and keep $10 on hand
as liquidity so that if any of the owners of the $100 want any back they can
get it. Thus, you have $190 of value passing around from a base of $100.
You've just got to be careful not to loan too much out or you run out of
liquidity and then the system stalls.

> which is frequently, unfortunately

Frequently by what measure?

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mrtron
Interesting chart that shows the market may be worse off than expected:

[http://img.photobucket.com/albums/v124/BCStud31/99problems_g...](http://img.photobucket.com/albums/v124/BCStud31/99problems_graph.jpg)

~~~
Xichekolas
I'm kinda sad you got buried for that... I laughed to no end... even if it is
off topic.

~~~
mrtron
I minored in economics and had an amazing prof for monetary economics. Long
story short, he worked for the Bank of Canada doing basically what your
Federal Reserve chairman does.

The amount of analysis and study that goes into interest rate adjustment is
mind blowing. They have 4 teams of experts running amazing models each in a
specific technique, and then each team independently reports their results to
the board which then decides what action to take. There is literally a
mountain of data and factors that come into play.

Anyways, the gross oversimplification of the entire process across the news
world today resulted in me posting a dumb (I am glad you also found it funny)
picture.

edit: I feel like I am hedging my karma here against people that do not enjoy
the odd bit of humour.

edit2: I just remembered a whole lecture that discussed the reason that for
interest rate adjustment to work well, everyone has to have full confidence in
the federal reserve. So, since confidence levels impact the effectiveness of
adjustments, they were probably sitting on this rate hike hoping to do it at
the standard time (which was actually bumped up), but to slow the plummeting
they took action a bit earlier which may hurt their credibility and the change
might not help very much.

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jey
This seems apt: [http://news.yahoo.com/nphotos/Ben-Bernanke-Ben-Bernanke-
Fede...](http://news.yahoo.com/nphotos/Ben-Bernanke-Ben-Bernanke-Federal-
Reserve-Board-
Chairman/ss/events/bs/013006bernanke/s:/ap/20080122/ap_on_bi_ge/fed_interest_rates/im:/080121/480/ccb619bf589e483ba6d90ec2800798cf/;_ylt=AgEdcbukJC9KYe4xZ15KeFpv24cA)

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david927
75 basis points wreaks of desperation.

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wallflower
Banks can lend out 10 times their assets. When they have to do a write-down,
they are reducing their asset base (and the amount they can loan) Does
reducing the interest rate help banks (because the way the Fed does it with
T-bill purchases)?

~~~
mrtron
You are slightly confusing the issues at hand here.

Most of the write-downs banks were doing were related to mortgage trading they
were doing, not mortgage issuing. There was not _that_ many banks involved in
the sub-prime business and losing a lot directly.

Banks are quite well hedged against interest rate flux fundamentally ...since
they make prime + x on loans, and pay out prime - x on balances.

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dcurtis
I keep hearing the word "recession," but no one has exactly defined what that
is, or if we're "in a recession" yet. Are there values that define when you
can say we're in a recession?

~~~
Dauntless
A recession is a decline in a country's gross domestic product (GDP), or
negative real economic growth.

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misterbwong
Recommended reading for anyone interested in what's going on in the world
economy. These are just starting points.

<http://www.marketthoughts.com/z20060921.html> (yen carry trade)

<http://en.wikipedia.org/wiki/Fiat_currency> (fiat currency)

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Dauntless
Wait for it:

...

HYPERINFLATION!

~~~
Xichekolas
Eh, main drivers of inflation right now are food and oil, neither of which is
affected a whole lot by fed funds rate. Food prices are high for a variety of
policy/trade/weather reasons (corn has skyrocketed due to US ethanol policy),
and oil prices are high because, well, it's oil.

~~~
mynameishere
Oil does not cause inflation. Genuine shortages could inch up prices, but
there really are no shortages right now. The usual cause of inflation (and the
_only_ cause of hyperinflation) is always the same...

[http://en.wikipedia.org/wiki/Image:Components_of_the_United_...](http://en.wikipedia.org/wiki/Image:Components_of_the_United_States_money_supply.svg)

~~~
david927
>Oil does not cause inflation But increased demand often increases prices.
You're talking about monetary inflation, but remember there's also price
inflation. If some good, x, is more sought after and the supply doesn't
increase, as with oil, the price will go up. Oil was $20/barrel five years ago
and hit $100 recently.

