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In an unprecedented move by the Federal reserve to cut the key interest rate to 0.25%, what could possibly be next for the FED?
Negative Interest rates; Paying Banks to borrow money from the federal reserve. This might not be as ridiculous as it sounds. Here is how;
Situation Report: The over-correction by banks in closing millions of credit card accounts, lowering credit limits, and raising interest rates to stave off an expected tsunami of credit defaults is only just beginning. Fears are credit defaults could rise to mortgage crisis levels.
Source: http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE4AG4UO20081117
This over-correction amounts to a log jam that exists between everyday consumers and banking institutions. Credit is nearly frozen solid. Actions taken by the Federal reserve is a panic move to free up lending. Before this can happen, future banking losses must be curtailed. This is why the Fed announced today that it will use "all available tools" to rescue the economy by buying up loan defaults, freeing up banks from mounting losses. In doing so, banking losses clot and consumer credit is restored. That's the theory anyway. The problem is an enormous margin for failure.
Lets assume the Fed buys up all bad loans, and banks borrow money from the Fed to restore consumer credit. Who and where are the consumers? Keep in mind, this credit crisis affects nearly 40% of sub par borrowers who are expected to default. The remaining 60% of borrowers are paying their bills on time, and still getting access to credit. So, who is going to be qualified for new credit under much stricter guidelines? Not the 40% that defaulted with bad credit scores. So consumer credit will be restored for people who have endured the storm with excellent ratings intact, and who already have access to credit. Certainly not enough new takers to turn around the economy. Small business loans won't fair much better in a deepening recession. Under this scenario, banks will borrow free money. They just won't have a healthy consumer base to restore credit to. And therein lies the problem.
With all of that free Fed money, banks will look for other investment opportunities. The end score of that game will be: FED - 0 / BANKS - 1000, with the Fed holding trillions in loan defaults.
So why should the Fed pay banks to borrow? As an incentive for banks to re-invest in the American consumer, with strict guidelines to re-engineer lending. Such as prohibiting predatory lending practices on the poor. With credit re-engineering, lenders can assess risk under current conditions, assign a modified credit rating, provide free financial counseling, and cap interest rates 10% above prime. Lower rates on the poor decreases the likelihood of credit defaults.
The "turn around" of every American who has defaulted on a loan is a huge game player. These "consumers" number in the millions. Simply denying them credit without reprieve will be far more damaging in the long term. Credit re-engineering is aimed at protecting those that have defaulted, due to bad lending practices, and is a required step towards getting our economy out of the ditch and back onto road.
The bottom line to restoring our economy is the consumer. Create good paying Jobs. And restore consumer credit. In that order.
