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Interest Rates Drop Again...
Posted by on Saturday, February 2, 2008 at 10:40 AM (PST)
"The Federal Reserve cut a key short-term interest rate by a half-percentage point, the second significant rate cut in just over a week, in an effort to stave off a growing risk of a national recession..." CAR Newsline, Wednesday, January 30th, 2008 To those of you that are still trying to figure out exactly what is being said about our financial markets, I thought I might try and simplify things for you. So here goes... When homes were selling quickly, the banks had extra money to give away and so they incentivized the public in the following manner:
The banks didn't really worry too much about the default rate of these loans because the housing market was booming. Secondly, and more importantly, the banks were not holding on to the loans they made. In otherwords, once the banks made these risky loans, they would group many of them together and sell them in the financial markets (secondary mortgage market) so that they could have cash available in their bank to loan more money to other customers. With the housing market and economy slow down some people began to default on the loans. The secondary mortgage market also realized the riskiness of the loans and decided to stop buying these loans from the banks. When that happened, we had the first real problem with the banks and mortgages. The banks had no money to lend to people because they had lent out money they expected to recieve from the secondary mortgage market but they weren't receiving it. In effect, the banks had over-leveraged themselves. There was in fact, a shortage of money at the banks. In order to counteract their problem, the banks had to tighten their lending requirements and raise rates. The Federal Reserve is cutting short-term interest rates in an effort to stimulate more money back into the banking system and help restart the housing cycle again. |
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