Monday, Oct. 13
Posted 2 p.m. Eastern

Reader e-mails

Here are a few e-mails from readers dealing with last week's emergency interest rate cut, bailouts, and the ongoing financial mess. Along the way, I've interjected a few comments of my own.

Leading off ...

"I agree with your statement regarding the Feds making another interest cut. After several cuts nothing has changed and another cut is only going to make things worse. Why can't they see that? The people that try to save money or invest in the banking market are the ones who get hurt. In the long run this effect everyone."

Batting second ...

"Here we go, everyone is looking for someone to blame for this current financial crisis. Remember when the savings rate went negative for the first time? That was the beginning of the end. The lack of financial literacy in this country is staggering. This whole problem is caused by the keeping up with the Joneses/self-entitled mentality. Buy the most house you can afford, lease two cars, use credit cards you can't pay off, get a adjustable rate mortgage, etc. I believe there will be a fundamental shift in the housing market to medium to small houses within the next few years and large tracts of McMansions will remain unsold as only a select few will be able to afford them. The easy credit has already started to dry up and taxes will have to be raised to cover all these bailouts. Unemployment is rising and I believe things are going to get much worse before they get better. Americans still have not realized they need to change the way they think about money, they can't continue to live a borrowed lifestyle. Until people start to save and stop buying things they can't afford this economy will not turn around. There are consequences to your actions and no amount of government regulation will save people from making stupid descisions. It is a shame that those of us who did not attend this party will also be forced to clean up the mess with our tax dollars. I wish I had some empathy for the people who got themselves in trouble but I do not, I believe we reap what we sow so get ready for a big harvest! -the voice of reason"

If you agree with the above viewpoint, buckle your seatbelt for this next e-mail.

"How come the federal bailout isn't to the taxpayers? It seems the bottom line is 'getting the economy moving', wouldn't provide all mortgagees (1st, 2nd, HELOC) a one-year moratorium on their loans provide more stimulus? If everyone had that money they are pouring into the never ending black hole or loan principle, interest, taxes, etc. they would spend a lot of it buying the cars, clothes, and toys that the retail sector is so interested in selling. The banks would be happy because they'd be getting their 'toxic' debit paid and the American taxpayer would feel that they got something for all this money."

As I interpret your e-mail, you are suggesting a 12-month vacation from mortgage payments for all homeowners? That is not financially feasible. The $700 billion bailout is about $5,800 per household (assuming 120 million U.S. households). While not everyone has a mortgage, and some residing in inexpensive areas would have their payments covered by $5,800, the vast majority of mortgagees have annual payments well in excess of $5,800.

However, 12-month moratorium or not, there are plenty of people residing in homes they cannot afford. A great many of those are in the "black hole" of loan principal, interest, and taxes you describe because they've already spent it buying cars, clothes, and toys of the electronic variety. Giving them a year off from house payments only delays the inevitable by about ... hmm, 12 months.

And finally ...

"I currently have a mortage rate that changes yearly. It cannot go up or down more than 2 points a year--currently sitting at 6.25 (percent). My equity loan is tied to the prime rate. What do you think I should do with these?"

This reader's question gives me the opportunity to highlight something of great importance to homeowners with adjustable rate mortgages and pending rate resets. While I don't have enough specifics to answer this reader's question, my hope is that by highlighting this issue, we can address a circumstance faced by a number of readers.

Consider two neighbors, both with adjustable rate mortgages due to reset, say, Dec. 1st. The difference is that one loan is pegged to LIBOR and the other to the one-year Treasury.

The LIBOR-indexed loan is poised for a nasty payment increase while the neighbor with the Treasury indexed ARM will see a substantive decrease in interest rate and monthly payment.

This can lead to two wildly different approaches. The homeowner with the Treasury-indexed ARM isn't compelled to refinance right away, particularly if the reset takes their rate below the 4 percent mark for the ensuing 12 months. This is also a huge sigh of relief for a homeowner that is underwater and unable to refinance as it buys them at least another 12 months of affordability and being able to chip away at the loan balance in hopes of eventually refinancing before the interest rate rebounds to a higher level.

But the LIBOR-indexed loan screams "Refinance now!" to anyone that can. With LIBOR above 4 percent, and it could be as high as 4.75 percent in the case of the 3-month LIBOR, a prime borrower could well see their rate reset to as much as 7 percent. In that case, refinancing into a fixed rate loan still means a big payment increase, but with fixed rates below 7 percent, the payment will not be as high and the homeowner can rest assured that it will never change. It is the stability of a fixed monthly payment that adds some much-needed predictability to the household budget and enables homeowners to map out a saving plan with staying power.

Unfortunately, many homeowners will be unable to refinance themselves out of harm's way because they are upside down. If you suspect difficulties in staying current with your payments post-reset, contact your lender at once.

Wednesday, Oct. 8
Posted 8 a.m. Eastern

Fed, other central banks cut rates

The Federal Reserve announced a half-point interest rate cut in a coordinated move with other central banks in Europe. The move was widely expected, particularly following Chairman Bernanke's remarks yesterday, which gave the green light to an intermeeting interest rate cut.

The Fed has been working to ease the stalemate in interbank lending in two ways: making additional credit available, and now reducing the cost of that credit. Will it work? The jury is still out.

As for us consumers, I wish there was better news to share. Savers will see their interest income undercut -- again -- with retirees living on fixed incomes being particularly hard hit. With the stock market taking a beating, many financials cutting dividends, and interest income on the downswing versus one year ago, many retirees will be forced to dip further into their principal to make ends meet. Not a pretty sight.

On the borrowing side, the impact on credit card rates will be limited. We're already seeing credit cards at their floor rates, a point where rates will hold regardless of how far the Fed cuts benchmark rates. Only consumers with top-notch credit will benefit through lower credit card rates, with marginal borrowers not as likely to see such a reduction. Issuers have been boosting margins for riskier consumers, but not so on their best credit consumers.

Rates for home equity lines will retreat, but with lenders freezing lines of credit, the cut won't entice additional consumer borrowing and spending. That's just as well, considering how we got into this mess.

This may reverse some of the sharp jump in LIBOR seen in the last month, but make no mistake -- homeowners with LIBOR-based ARMs need to brace themselves for sharply higher payments on the next reset. LIBOR is up 150 basis points in the past month and that won't go away overnight.

One final note, the coordinated nature of the rate cut likely prevents undercutting the dollar. With the dollar having rebounded from $1.60 per Euro over the summer to $1.37 now, there was concern that additional rate cuts would undermine that progress. Since the European Central Bank also cut interest rates, that should prevent a decline in the dollar that would otherwise have been much likelier. And brace yourselves, because this isn't the last of the rate cuts. Expect the Fed to cut again at their month-end meeting on Oct. 30.

Fed Outlook archive