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EScroogeJr (< 20)

Bernanke's rate cut



November 03, 2007 – Comments (3)

I have to admit it: the pessimists who saw it coming were right and I was dead wrong. I expected the 4.75% barrier to hold because of the fact that GDP is growing, house values are holding on (a mere 4.2% dip after a 100% rise is but a tiny correction after a monstrous rally), and inflation is on the rise. Apparently, Bernanke was even more anxious to deliver instant gratification to homeowners that I gave him credit for. 

This rate cut against the backdrop of a robust economy is really bad news. Until now, rate cuts usually followed recessions. But now the policy is to cut rates to prevent a recession. What we're essentially saying is this: our economy is still strong, but it's only because we're cutting rates. Note that it's not even enough to keep the rates low (4.75% is very low by historical standards). No, if we just keep them low, we'll go into recession, or so we think. The necessary condition of our economic prosperity is that our low rates must be getting ever lower. When was the last time we had high rates? Oh, it was very long time ago, sometime in the last century. Since then we always had low rates, something like 2%-4%. We like our low rates, and we can't raise them anymore. We've tried once, and our economy nearly gave up the ghost when we briefly touched 5.25%. Will never do it again. Remember I said some time ago that we may never see the 5.25% rate again? Well, the way things go, I'm wondering if it's the time to say goodbye to 5% if not to 4.75%. With so many homeowners demanding annual property appreciation, that barrier cannot be defended. It's true, of course, that a barrel of oil will now cost even more pounds of dollar bills, but that's another story.


3 Comments – Post Your Own

#1) On November 03, 2007 at 12:44 AM, camistocks (43.41) wrote:

Sure, Fed Fund rates will go down, I bet to 3.5%, maybe lower, but over the very long term (10-15 years) rates will go up again, to 10% or so. It's like a cycle.

Rates went down in the 1950s and then went up during the 1970s. They are now down and will go up again. Just IMO. You can have a look at this chart.

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#2) On November 03, 2007 at 2:32 AM, EScroogeJr (< 20) wrote:

In the 1970s house prices did not depend on mortgage rates. Mortgage was a way for you to pay for bricks and cement. These were fixed costs and they would not get any cheaper just because you have to pay a higher interest. But today mortgage is a way for you to enrich the guy who sells the lot to the construction company. This cost is not fixed, it's variable. How much you can pay under this or that interest scenario minus the cost of bricks and labor is exactly the price you  will pay for the land. The first component is determined by the Fed, so the price of a house is now a function of interest rates. So, in the 1970s it was possible to quadruple rates, and homeowners would hardly notice. Today, if you set the rate to 17%, prices will respond by falling until land costs $0, and that means 70% devaluation in most big cities. So if today Bernake tries, say, 6%,  the growling of the homeowners will force him to go back to 4.5%. And there is no way to cross that line becuase when houses double from today's level, 2.5% will be new theshold you can't cross, then when houses quadruple, you can't go over 1.25%, and so on.

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#3) On November 03, 2007 at 10:38 PM, floridabuilder2 (98.75) wrote:

good post scrooge

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