It is clear that a rate cut is coming by the 18th of September.President Bush offered Federal help Friday to aid thousands of home mortgage owners at risk of foreclosure.'We will deliver help and hope to American families who need it', he said.
Of late foreclosures have jumped especially for sub prime borrowers with poor credit ratings or low incomes.
The President unveiled several initiatives to help people at risk keep their homes.They include reforms in tax laws to help troubled borrowers refinance their loans.But he hastened to add that it was not the duty of the government to bail out speculators.He cited both 'excesses in the lending industry' and 'optimistic homeowners who took out loans larger than they could afford,' as reasons for the mortgage crisis.
But it is clear that the Fed has realized that swift action needs to be taken.Bernanke spoke about the 'stability of the financial system.' Experts have taken this to indicate that for the first time in a very long time the Fed intends to deal with with financial stability and economic growth as two distinct issues.This would mark a departure from the policies followed by Alan Greenspan who was preoccupied with interest rates and economic growth alone and who many people are convinced is responsible for the build up of the housing bubble and the present crisis.
So what is the extent of the problem?It is much larger than most people admit.Last year there were 1.2 million foreclosures.This year the number is expected to hit two million, or roughly one in 62 US households.Put the two together and you understand what has happened out there in the last two years.
The remarks of the President and the Fed chief have made it clear that a rate cut is coming.But will it help?The Fed rate has gone up from 1% in 2003 to 5.25% last year.The resultant increase in mortgage rates meant that many people were simply unable to repay.The mortgage institutions then took over the property and found that it was worth much less in the market than the loan given against it!Add to it the costs of foreclosure and you get a true picture of the crisis.These companies are thought to have already lost $200 billion in the value of their investments this year alone.This figure is perhaps higher than the combined profits of all the top financial companies put together for the last several years.So is a 25 basis point or a 50 basis point cut in the Fed rate going to solve the problem?It is highly unlikely.It may cheer up the stock market,improve liquidity and temporarily divert attention from the crisis,that is about all.The crisis will go away only once the housing market recovers and property prices start climbing again.This will take some time.Moreover figures published Thursday showed the economy grew 4% in the second quarter.So it would seem that the Fed may not be able to cut rates too far.
So what is the best solution?The government has to ensure that people are able to stay on in the homes they have bought and gradually repay what they borrowed for it.Foreclosures will simply increase the problem.More houses coming on to the market will drive down prices further and cause another downward spiral which now threatens to spread to other parts of the financial system.