Did the Fed Make a Good Bet?

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Federal Reserve

Source: web

Last week, stocks soared when the announcement was made that the Federal Reserve would be injecting $40 billion a month into bond purchases. But it wasn’t only looking to cut rates – a decision that was controversial all along – but it also wants to ensure American taxpayers start spending again. The question is – is that even remotely possible?

Last Thursday, during a Federal Open Market Committee meeting, Fed Reserve Chairman Ben Bernanke explained the decision to go into a third round of bond purchases. Of course, the primary goal was to lower interest rates, which should equate to higher prices in the mortgage industry. It as also meant to stabilize the stock market. This so-called wealth effect, according to Bernanke, should “make people feel wealthier and more willing to spend”.

Here’s the reasoning:

The lower interest rates and higher home prices should start off a chain event. It should result in a massive boost to the American economy while also making people “feel” wealthier. If that happens, we can expect to see more spending. Is this a responsible move for a government that knows the economic landmine many Americans are feeling? After all, it seemingly matters little that Americans can’t find jobs, are increasingly turning to social programs and the country as a whole already is facing historical $16 trillion deficit. It’s akin to looking outdoors and seeing a beautiful day, but you’re not allowed to go outside to enjoy it. The stock market may improve and the interest rates could drop – but if there’s no money in the bank, people aren’t going to meet this new proposition with any kind of enthusiasm. It doesn’t matter how low the rates go, people can’t buy homes if their credit ratings have suffered both during and after the recession. They also won’t buy homes if they can’t afford downpayments and all the other fees associated with securing a mortgage.

Still, Bernanke is banking on those factors not being significant.

If people feel that their financial situation is better because their 401(k) looks better or for whatever reason – their house is worth more – they’re more willing to go out and spend,

Chairman Ben Bernanke told reporters.

That’s going to provide the demand that firms need in order to be willing to hire and to invest.

In theory, that sounds great; unfortunately, reality paints a different picture.

Bernanke promises to buy bonds until the need no longer exists. Further, he reiterated the belief that short term rates would remain low through at least 2015 while also stating the commitment that these efforts would continue well after a true recovery begins. Still, there are several analysts who continue to insist home prices won’t see as big of an impact and certainly when contrasted against the other problems the nation faces, including those troubled credit histories.

Anytime interest rates are lowered – or are anticipated to drop – the Dow does well. This time was no different; in fact, it’s up by 4%, or 500 points, since the late August announcement that the Fed would be lowering rates soon. Investors are already chartering their courses of action and perhaps even opting for the riskier options.

So what are analysts really predicting? One of Moody’s top analysts, Mark Zandi says we can expect to see thirty year mortgages drop from an verge of 3%. Currently, we’re seeing about 3.5% interest rate. Experts say we can see a spike in refinancing efforts, complete with lower interest rates, which should benefit the economy as a whole. One school of thought follows the “spend more with refi” theory.

Our own analysts have different views:

What likely is to happen is people will take advantage of the lower rates so that they can pay off credit card debt, catch up with their automobile loans and other financial obligations that’s put them in tough financial positions in the past few years. What’s left, if anything, will cover the holiday expenses. The first of the year, we’re back at square one if there’s no change in the employment numbers. Student loans continue to be a problem and there’s a growing number of consumers who are taking advantage of the recent ruling that forces the five big banks to re-modify mortgages for consumers who are upside down in their mortgages or are at the foreclosure level. These are all important factors to keep in mind and they will play a significant role in how successful the Fed’s commitment becomes.

So how do you feel about the Fed’s announcement? Will you be taking advantage of the lower rates and if so, what do you plan to do? If you do re-fi, we’d love to hear your thoughts on how you plan to spend any equity you get out of it. Will you being paying off credit card debt or adding to it? Be sure to like our Facebook page and follow us on Twitter too as we continue to bring our readers into the discussion. It’s all about you!

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About Author

David is a CPA and has spent the past decade as a financial adviser helping clients meet their fiscal objectives. With an appreciation for journalism, he has spent the past few years overseeing several financial columns as well as writing two previous finance blogs. He resides on the East Coast with his wife and two sons and has guided many through the recent recession while providing a no-nonsense approach to spending and saving.

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