Economists aren't sure if the Federal Reserve will raise the short-term interest rate to 5% at their meeting on Wednesday. There is a lot of talk and debate about this. If they do, it will go up by.25 percent 16 times in a row, since the lowest point was 1%. Most people seem to think that Fed Chairman Ben Bernanke's comments have given mixed messages about whether or not this meeting will be a good time to stop. Or, will they keep raising rates over and over again for the rest of the year? No one at the Fed seems ready to say what will happen. This isn't surprising, since the economy also seems to be sending mixed messages. Even though the risk seems small, some economists worry that stopping rate hikes would cause inflation to rise quickly.
The fact that many economic indicators take months to show their full effects makes it hard to know how far to go with a rate-based fight against inflation. Last month, the average hourly wage went up sharply, which may have been caused by a drop in retail jobs and an increase in manufacturing jobs. This doesn't look like a sign of real inflation. Instead, it looks like a change in the job market. Only a small amount of inflation was caused by the rise in oil prices, but if the cost of fuel spreads through all manufacturing and transportation in the next 60 days, it could cause prices to go up all over. Bernanke and the Fed need to decide if it's time to slow down, but they can't be sure how fast they're going.
Some economists blame Alan Greenspan, who was in charge of the Fed from 1987 to 2006, for the inflation, the recession, and the crash of the tech stocks, which caused the stock market to lose a lot of money. In those 19 years, the Fed changed its policy seven times, going back and forth between raising and lowering interest rates. Several of these changes happened quickly and dramatically, and the results were, of course, big. From the crash in 1987 until 1990, when inflation started to rise, the Fed raised interest rates. Then, during the recession of 1990–1991, they cut rates by a lot. In 1994, Greenspan raised rates too much because he was afraid of inflation. However, the fear of inflation was overblown, and it never happened. It did, however, make Wall Street's stock market very bad. As a result, when rates slowly went down and more money was put into the economy, a huge bubble formed in high tech and the stock market as a whole. Both the Dow and the Nasdaq went to new heights as a result of this almost irrational optimism.
When Greenspan changed his mind in 2000 and decided to quickly raise interest rates and cut off liquidity, the stock market crashed and went into a three-year bear market. The Dow lost almost half of its value, and the Nasdaq lost more than 70 percent. Later in 2000, Greenspan started a plan to lower rates all the way down to 1%, which many people think is a rate of interest that is too low. He did this because he was afraid that deflation would lead to a recession, which never happened. Since 2003, the Fed has been raising interest rates without stopping.
One thing that isn't getting a lot of attention is how these steady increases affect the bond market. During the time when interest rates were kept artificially low, Wall Street investors drove up the prices of mortgage REITs and other investments that were affected by interest rates to astronomically high levels. Now, Alan Greenspan and Ben Bernanke have started a plan for the Fed to raise rates every six weeks. Because of this, mortgage REITs, muni bonds, and other investments that depend on interest rates have dropped.
Because of the inversion in the bond market, mortgage interest rates have changed in a way that hasn't happened in over 20 years. Fixed-rate mortgages, which usually have much higher interest rates than adjustable-rate mortgages (ARMs), are about the same or lower right now. This makes fixed-rate home loans more appealing to both buyers and current homeowners, but if the rates on adjustable-rate mortgages (ARMs) go down, it could be a more expensive choice in the long run. But the problem for many homeowners is that their current ARM, which used to be a great deal, now costs them more each month. Even ARMs that are based on an index that is usually stable, like the Cost of Savings Index (COSI), which is an average of the interest that banks pay on savings accounts, have gone up a lot in the last year.
"Karen Pooley, President of Star Mortgage, Inc. in Tampa, Florida, said, "It's hard to tell what will happen," but she told her clients with adjustable-rate mortgages (ARMs) that their best bet right now is to wait out the current increases. In the past, ARMs have always done better in the long run than fixed-rate mortgages, but you have to be ready to deal with changes as they happen."
"I have helped a few people who were having trouble making their payments and had enough equity by refinancing them with a fixed-rate mortgage at about the same rate and giving them cash out." Ms. Pooley continued, "This lets them skip a few payments and gives them some extra cash to help cover their new, slightly higher payment."
Alan Greenspan said in a speech at the beginning of 2004 that ARMs were a better deal for homeowners and that many of them could have saved thousands of dollars a year over the last 10 years if they had one. But this was before the Fed's constant rate hikes had caused the average rate on all mortgages, especially ARMs, to go up so much. Ben Bernanke and the Federal Reserve should think about how the constant rise in rates affects homeowners who followed Alan Greenspan's advice but now have much higher payments than they expected. Industry reports say that the number of foreclosures is on the rise, which could be an economic sign that Mr. Bernanke and the Fed should stop raising interest rates.
