federal reserve

What to do after the Fed's moves

Smart steps after the Fed


Richard DeKaser, chief economist at National City Corp., urges all Americans fretting about the state of the economy to pause and take a deep breath.

"I don't think overreacting is appropriate," he says. "Calls for a return of the Great Depression are greatly exaggerated, in my view."

Still, DeKaser does not downplay how surprised he is by the recent meltdown in the U.S. financial markets.

"Without a doubt, I did not see what happened in the month of September playing out," he says.

Recent financial tumult prompted the Federal Reserve to act with an emergency 50-basis-point reduction in the target federal funds rate Oct. 8. The Fed's open market committee voted 10-0 to cut rates in advance of the Fed's next scheduled meeting Oct. 28 and Oct. 29.

The surprise rate cut was made in coordination with other central banks across the world, including the Bank of England, the European Central Bank and banks in Canada, Sweden and Switzerland.

The coordinated action signals growing recognition that the problems afflicting U.S. credit markets have spread across the world, according to DeKaser.

"It suggests a uniformity of response across the world," DeKaser says. "This truly has become a global problem. Just as a unanimous vote of the (Federal Reserve) open market committee signals unity and resolve, so too does a widely dispersed rate action."

DeKaser says the coordinated rate cut is just the latest in a series of moves by the Fed and the U.S. Treasury designed to restore faith to markets badly shaken by turmoil on Wall Street, especially the bankruptcy of investment banking giant Lehman Brothers.

"Arguably, a lot of this had to do with the execution of the Lehman failure," he says. "The traders I know on the fixed-income desk really believe that the Lehman failure -- and its repercussions into money market mutual funds, then into the commercial paper market, then into interbank funding market -- really rippled in such a way as to just great demoralize confidence. And it took on this downward spiral."

As a result, there is a widespread "unwillingness to take on long-term commitments," DeKaser says. Evidence of such fear can be found in recent economic indicators ranging from rising initial claims for unemployment insurance to dropping employment levels and sliding housing activity.

"The common thread here is that anything that requires some degree of confidence just abruptly fell of the table," he says.

Now ... or never?
The Fed's emergency rate cut itself is unlikely to impact mortgage rates significantly, as cuts in the federal funds rate do not directly affect mortgage rates.

This is especially true of fixed-rate mortgages. While such mortgages sometimes decline in the wake of a Fed rate cut, they are just as likely to rise.

By contrast, adjustable-rate mortgages can be a bit more sensitive to Federal Reserve rate decisions. Many ARMs are pegged to the London Interbank Offered Rate, more commonly known as LIBOR. LIBOR rates usually closely track the federal funds rate. However, today's economic turmoil has caused the spread between LIBOR and the federal funds rate has become uncharacteristically wide, meaning many people with ARMs will not see their mortgage costs fall as they typically would after a Fed rate cut.

The recent cascade of negative financial news has left many Americans shell-shocked. DeKaser says Americans will have to look at their own economic situation and decide for themselves whether or not now is the right time to buy.

"It's going to depend on the individual," DeKaser says. "For those who are feeling very secure in their situation, of course they should proceed as planned.

"But on the margin, there are going to be more people who are less secure. Those folks are going to have to do their own calculations as to what there prospects are going to be."

After leaving rates unchanged for several months, the Federal Reserve surprised many observers by cutting the target federal funds rate by 50 basis points.

The move is thought to be a reaction to recent turmoil in the world's financial markets.

The central bank's rate cut will not have a direct impact on mortgage rates. Rates may fall, but they could just as easily rise.

Bankrate's rate tables can help you compare mortgage rates in your area.

Bankrate can also help you calculate whether a fixed-rate or adjustable-rate mortgage is better for you.

To determine whether refinancing is right for you, use Bankrate's mortgage calculator.

-- Chris Kissell




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