The Interest Rate Isn't the Problem.

Hey everyone,

I realize my posting schedule has been non-existant;however, it is not without reason, Intigril Capital Management has been working towards putting a lot more money into the market and I've been tied up. That and a little thing called EARNINGS SEASON.

However, I'm not going to talk about earnings today. I want to talk about the federal reserve's recent decision to cut interest rates. Now, there has been a lot of talk about this decision- isn't there always? - and two camps have been:

1) It was really important the the fed cut rates
2) Who cares about the rates, they aren't going to make a difference.

I agree with the second opinion, but it is for the reason that the first opinion is correct.

Confused?

Right now, despite the rate cuts, you are still seeing mortgage rates increase, regardless of whether they are credit card interest rates, 15 year mortgages, or 30 year mortgages. The problem isn't the supply of money. Its the demand for it. For years, via subprime lending, we greatly magnified demand for home loans and further amplified this demand by mass approving Home Equity Lines of Credit (HELOCs).

If a bank assumes that very few people default on their loans and at the same time increases the number of loans, then you can lower interest rates, because losses on a few defaults can still be covered by the few defaults. However, volumes for mortgages are down. Instantaneously, the interest rates go up, because their aren't enough people to spread around the losses to.

Therefore, a major component of the credit freeze is not the supply, it is the DEMAND.

Now, supply is really the best that it can be. With federal rates this low , banks do have a reasonable margin. So the reward for banks who chose to lend is still there. However, with lower demand AND a weak economy - the risks simply outweigh the reward.

So, was the rate cut important?

Yes, because it helps keep supply up.

But will it make a difference?

Not until the economy recovers and demand returns. Until then, the risk of lending will outweigh the rewards of lending.

-Mansij Hans, E.I.T.
Member, Intigril Capital Management.