America lives out of its means

By Herb Greenberg

Photo: America lives out of its means

With news Tuesday morning that the Fed is cutting the Fed Funds rate by three-quarters of a percent, it’s official: Things are worse than they seem with the economy.

The Fed, pushed by shattered worldwide investor psychology, is pulling out all stops to shore up confidence. Treasury chief Hank Paulson went so far as to call this latest cut a confidence builder.

Trouble, as has been pointed out here previously, is the “what if they give a party and nobody comes” syndrome. In this case, what if they do a big-bath cut and it doesn’t help?

The Fed did the right thing by cutting just a quarter of a percent a few weeks before the holidays. That would give them a chance to see how the consumer was really doing.

They got the answer pretty fast: The consumer is doing horribly. The value of their homes, especially in the most inflated parts of this country, has deflated. The availability of credit via their homes or other sources has deflated. The value of their 401ks and IRAs has deflated.

As a result, their confidence has been crushed, and it’s unclear how many rate cuts it will take to reverse the trend. The trouble, away from Wall Street, is really quite simple: America has been living out of its means, fueled by a Fed that made credit so cheap that it appeared, at one point, you were getting paid to take the cash. With today’s cut, the Fed Funds rate will fall to 3.50%; last time it was that low was August 9, 2005, when the market was higher than it is today. By contrast, it sank to 1% on June 25, 2003. Mortgage rates, meanwhile, for 30-year loans are averaging 6.33%, still well above their boom levels; ditto for the prime rate.

Here’s the problem: Even if rates once again fall to boom-era levels, credit standards have tightened to the point that even a little bit of sugar won’t help the medicine go down. And don’t go thinking everybody will refinance as mortgage rates slide. Unfortunately, their homes may not appraise out. Batten down the hatches: Ain’t over yet for the bad news — or the Fed.

Source: Seeking Alpha