Rate cuts by the Fed generally lead to a reduction in rates across the board. That equates to reductions in Treasury yields, reductions in the prime rate, reductions in bank savings rates and bank certificate of deposit interest rates. It also should lead to reductions in mortgage rates, auto loan rates and commercial loan rates. Unfortunately, lending rates are not headed measurably lower. We are seeing a slight reduction in 30 year fixed rate mortgages and a reduction in the prime rate but little else.

The rate cut by the Fed was in reaction to their unease regarding the problems and credit and impending retrenchment in economic activity. The Fed funds rate should have at least some impact on some consumer loan products within the next 30 days. Variable interest rates loan products such as the rates set on many credit cards and home equity lines of credit are tied to the prime rate. As rates on prime rate based loans and some adjustable-rate mortgages go down this may provide some relief for those homeowners struggling to make their monthly payments or free up discretionary income for other expenses. The impact may take some time to tell whether it is measurable or just indeterminate. But this is payment relief that banks may offer with the reduced prime rate, limited payment relief, not new lending.

An immense barrier to low rates for consumer and business lending this time around is whether the banks and other financial institutions will take advantage of their lower borrowing costs and pass them on to borrowers with new loans. The first road block is finding good credit and quality borrowers. Borrowers with challenging credit and income constraints are a dime a dozen. This is what drove us here in the first place. If some of the major banks are working feverishly to clean up the asset side of the balance sheet, it is hard to fathom how they will want to go out on a limb to loan money to anyone other than the most creditworthy borrowers. Of course this is a circuitous puzzle. Restricting credit slows the economy and a slow economy lead to deteriorating credit and income conditions that make banks more reluctant to lend.

Lenders are still looking for new business from those solid borrowers. Mortgages and auto loans are still being originated by the underwriting standards are simply more restrictive. And the interest rates and fees that are being charged are increased at every turn. One might conclude that these actions are necessary. Dropping rates will help the economy some, but the banking system needs to increase capital, which has been going well thanks to the Treasury, and clean up its asset side. Cleaning up the asset side helps when the capital structure is on sound footing but it is a slow process.

The preferred stock program of the Treasury is brilliant. It helps provide the sound balance sheets. Loans will have to continue to be placed in work out scenarios, loans will be sold, and assets will be repossessed and foreclosed on. This will not end with lower interest rates or $700 billion from the Treasury. It helps, it speeds it up, but the trouble will take time to be worked out. Loans are not going to be written for 5% down on a $500,000.00 home purchase at 5.75%. Who on earth wants to invest $475,000.00 for 30 years at 5.75%. Discover bank is offering 5.21% on a five year CD which is a federally insured bank. Hmmm, invest in a mortgage or invest in a CD? Asset backed securities can be sold only with higher rates and greater asset quality. This formula does not bold well for a new round of bank lending or demonstrably lower loan rates.

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