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We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.
The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.
These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.
When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?
Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.
Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.
Monday, April 28, 2008
Too Rich for the Rebate? How the Stimulus Can Help You
Kathryn Tuggle
FOXBusiness
Taxpayers raking in more than $87,000 per year won't be getting any of the stimulus money hitting some Americans’ bank accounts Monday.
Couples who make more than $174,000 per year won't see any of the money either.But what people in this income bracket are getting will far outweigh a $600 check, some experts say.
In addition to the payments, the stimulus plan includes a provision that makes it easier for people who own expensive homes to refinance their mortgages.
That component raises the size of a "conforming mortgage--" ones the federal government has agreed to help refinance, to $729,750 from $417,000. The interest rate on the refinanced loans’ is 1.27% lower than regular loans. What’s more, these loans can be sold to Fannie Mae or Freddie Mac, which gives the mortgages the backing of the federal government.
Lower interest
rates on mortgages will presumably mean homebuyers can afford to pay more for their homes, and also allow those looking to
refinance to do it for less.
All of this means a shot in the arm for the housing market, said Michael Ashley, president
of Lend America Incorporated.
"Real estate has always led the economy either up or down. The government has to do something to inject credit into the economy, and the only medium they can really control is the housing industry," Ashley said.
"Now the idea here is, ‘let's increase this loan limit so more people can buy, and the housing market will turn around, and people in trouble with adjustable mortgages can refinance.’ It's a big deal for [the government] to do that."
Now is a good time to refinance your home into a low 30-year fixed rate, Ashley said, because home prices are down, interest rates are down, and with the increase in loan limits, buyers have more homes to choose from.
It is now possible to buy a house with 3% down, and the seller will pay the closing costs, according to Ashley. "This is exactly what the government wants because as long as these houses stagnate and continue to come down in value it's bad for the entire economy."
Ashley said he is not surprised the stimulus package includes the benefit for homebuyers and prospective owners; the only surprise, he said, is that the government waited so long.
"They missed the mark by a long time. They could have come out with
this six months earlier and it would have made a big difference for a lot of people."
For those whose incomes disqualify
them from stimulus checks, the loan adjustment will prove to be "much better" than $600, he said.
"I've been through the Regan era and seen all the ups and downs in the economy for the past 30 years. I've been around long enough to know what a stimulus looks like, and at the end of the day $600 is not going to do much for someone. However, refinancing your home and saving it from foreclosure, or refinancing and being able to bring your mortgage payments down -- now that's really something," he said.
Ashley is optimistic the loan element will be helpful. Others aren’t so sure.
Steve Habetz, president of Westport, Connecticut-based Threshold Mortgage, it’s become more expensive now to borrow money than it was when the stimulus package was first introduced, a factor that could offset potential benefits.
"The stimulus plan did temporarily increase the conforming limits to as high as $729,750, and of course all of us were ready to pop champagne at the prospect of all these borrowers refinancing," Habetz said.
"Unfortunately, since the proposal first started moving through Congress, the spreads between the treasuries and agency loans has spread significantly so that the borrowing costs on all loans has risen."
David Lykken, president of Mortgage Banking Solutions in Austin, said on the whole, the loan stimulus aspect is a positive because it increases access to programs that could decrease the number of U.S. foreclosures.
"Increasing the maximum loan amounts with Fannie Mae and Freddie Mac is important, because if we don't get that done there will be millions of homeowners that need to refinance, and if they can't that will increase the probability of foreclosure," he said.
Nevertheless, Lykken questioned whether the federal government has full grasp of the problem. What’s more, he suggested that programs that made it easier for people to buy homes and refinance were what led to the housing crisis in the first place.
In theory, he said, the loan stimulus is needed to stimulate the economy, but an unintended consequence could be a reheated housing market taking off before homebuyers' credit has recovered.
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