Thursday, November 5, 2009

President Obama: Low Interest Rates Is Only Part Of The Solution


This week the Federal Reserve Bank, known as The Fed, decided to keep the interest rate at which they lend money to commercial banks at 0% to .25%. The Fed is doing this because they believe that this will help the recovery of the economy and especially it will help bring back the housing market. This is partly true. Low interest rates make it easier for builders to build and buyers to buy, but is this what caused the problems in the first place? The answer to that question, in my opinion, is NO.

The bundling of mortgages into bonds that can then be sold to investors is an excellent financial tool to promote the growth of the housing market and the economy. The problem is that until this tool has some improvements made to it, better engineering, this financial tool will be too dangerous to use. What is wrong with this financial tool, the collateralized mortgage obligation (CMO)? The piece of the tool that needs work is its "electrical wiring". The way this tool is now wired, it can give the holder of this financial tool, the CMO, a terrible financial shock. That shock comes in the form of the CMO being worthless because the triple-A rating given to the CMO is also worthless. When you invest in an electric drill, you want to know that when you turn the drill on, you are not going to get the shock of your life. The CMO that came out of Wall Street with the bogus triple-A ratings knocked a lot of portfolios on their financial asses. Period.

So, The Fed keeping rates low is a good thing, but something has to be done about the issuance of the triple-A rating. I have written several times before that I think the Federal Reserve Bank should be the gate keeper of the triple-A credit rating much the same way that the Food & Drug Administration (FDA) is the gate keeper for our drugs. I know this is not perfect, but at least the credit rating agencies will know that they actually have to do the credit work on the bundles of mortgages before giving out their triple-A rating. The Fed also requires that commercial banks hold triple-A credits in reserves and therefore, in my opinion, The Fed is the right agency to pass on the creditability of the credit rating agencies' ratings.

Someone should tell President Obama what is broken and how it can be fixed. Keeping interest rates low is only a part of the solution.

Stay tuned.

2 comments:

Robin said...

I have to admit that being married to an economist I pretty much ignore all the financial news and wait for him to filter it all for me. Lazy, but efficient ;).

They just published the results of a "wellbeing" survey here today. Turns out Israelis are now beginning to feel more optimistic about the economy - spending is rising again and fewer people are listing the recession as one of their main fears.

moneythoughts said...

I can only guess at how much the Israeli economy is tied to what happens in the USA. Americans of all faiths travel to Israel when they have the bucks, and I am sure that is good for your domestic economy. But tourism is only a piece of the equation, as Israel exports software and technical support around the world. Cell phone software I understand comes from Israel, and isn't that a cruel irony when you think about what cell phones can be used for besides talking.