Download Why the Fed`s rate cuts won`t help you

Why the Fed's rate cuts won't help you
In its efforts to keep irresponsible bankers on Wall Street afloat, the Federal Reserve is spurring inflation, crippling the
dollar and cutting into retirees' incomes. And mortgages and car loans won't get any cheaper.
By Jon Markman
The Federal Reserve today will attempt to get out in front of the worst financial crisis to hit the world banking system in five
decades by slashing short-term interest rates from their current perch at 3% to the lowest levels in years.
But its effort will have little effect on the ability of the average American to get a cheap loan for a new home, car or college
education even as it has a large effect on U.S. banks' ability to fix their balance sheets by racking up fat profits.
If that sounds unfair, welcome to the latest episode of a brutal new American business ethic, in which the government bails out
bad bets by risk-taking banking executives in New York with money that it borrows from middle-class families and foreign
investors. The effort is gilded with fancy financial language and cloaked in the guise of a rescue that helps all citizens, but the
reality is that Washington is essentially robbing the poor to help the rich.
It seems odd, but these are extraordinary times. Normally, when the Federal Reserve cuts the rate at which it lends money to
U.S. banks, those banks in turn cut the rates at which they lend money to citizens and companies for personal and commercial
use. Simple enough. Yet in the past few months, banks have made three important changes in their usual practice:
They have not been passing all of their interest-rate savings to customers.
They have restricted lending only to most creditworthy, documented applicants.
They have cut the total amount they're willing to lend.
Good for banks, bad for you
Banks are taking these seemingly perverse steps in an effort to reverse the effects of the massive losses they have withstood for
lending too broadly to consumers and companies with lousy credit over the past five years.
They're pulling a big 180, which is as confusing as it is disheartening. Rather than providing funds to prospective home buyers
and business people with legitimate needs for moving into larger homes or expanding factory lines, records show the banks are
hoarding the low-cost money they're borrowing from the Fed and investing it in Treasury bonds paying higher interest yields.
They're then pocketing the windfall profits to repair their own ravaged balance sheets.
As if that's not bad enough, the Fed's swiftly conceived, unprecedented course of action harms the public in three other ways:
It boosts inflation by lifting the total number of dollars in circulation.
It undercuts the attractiveness of the U.S. dollar, which leads to higher food, energy and gold prices.
It cuts the yields of dividend-paying investments such as government bonds upon which retirees depend for steady income.
In other words, the Fed action helps imprudent bankers dig out of a hole by putting prudent citizens and foreigners in one. This
gives big financial businesses a shot at staving off disaster at the risk of cutting the spending and earning power of everyone
else.
Fed outwitted and outplayed
To be fair, the Federal Reserve never wanted to be in this position, and it told Congress as recently as a few months ago that the
U.S. economy was in such great shape that it had no intention of lowering interest rates in a material way anytime soon. But the
Fed's leaders, a dangerous mix of university professors and career bureaucrats, were drawn into a trap at amazing speed by
dark forces in the global financing system that they now admit they scarcely understood.
How could this happen? Albert Wojnilower, who was chief economist at Credit Suisse First Boston for a quarter of a century,
observes that the history of finance is rife with examples of financiers who successfully outwit their referees -- the accountants,
auditors, rating agencies, bank examiners and government agencies that are assigned to create and enforce rules.
Wojnilower, now an adviser to Craig Drill Capital in New York, points out that just as in sports, some of these officials may be
corrupt, indifferent, incompetent, or even hostile to the rules themselves, but they always fall behind the financiers. He notes that
as soon as lenders are freed of constraints -- as they were in this case by Bush administration officials eager to deregulate the
industry -- they are spurred by huge short-term rewards "to compete addictively with one another in taking bigger and bigger
risks.” Wojinlower says that eventually havoc breaks loose, forcing responsible government authorities to halt the chaos by
providing bailouts to participants considered too big to fail.
It's a bit ironic, and not a little sad, that government has come to believe it has to fight fire with fire. The Fed, whose leaders are
appointed by the president, is essentially trying to battle problems created in an era of overly cheap money and loose lending by
making money even cheaper and lending even more aggressively.
In just the past few weeks, it has broken all of its own rules by providing hundreds of billions of taxpayer funds to brokerages at
special auctions, opening a bigger "discount" window to permit a wider range of financial institutions to beg at the government till
and accepting weaker-than-normal collateral such as iffy mortgage-backed securities. The Fed has put the government in the
position of being the payday lender of last resort.
The Fed's hamster wheel
Just to top it all off, the Fed this week announced plans to allow the twin titans of government-supported mortgage finance,
Fannie Mae (FNM, news, msgs) and Freddie Mac (FRE, news, msgs) -- which have proved themselves horrible at managing
risk -- to make even bigger loans than they had previously. And it is telling banks to let individuals facing foreclosure to stretch
out their payments a little longer.
It is all a bit crazy, which is why many veteran financial advisers recommend that investors remain skeptical of rallies.
If the Fed cuts rates by three-quarters of a percentage point today, or even a full percentage point, there could well be a positive
reaction by stocks. But what you want to watch is the reaction of debt markets, not the equity markets. Credit investors, who are
the real masters of the global economic system, believe that the Fed is like a hamster in a cage that has to run faster just to stay
in place as events spin faster and faster out of its control. To have a chance at getting ahead by making money so cheap that
lenders will abandon their policy of distrust toward borrowers, the Fed probably needs to cut rates by a stunning 1.25 percentage
points today. Anything less, and after a short period of excitement the hamster will just go back on the wheel.