regarding a recent cut in the interest rate, what does this mean? What is a “key interest rate”? Is this to say that there are other interest rates besides the prime rate? (Seems you only hear about the prime rate.) Or, is it all the same?
“When the Fed cut a key interest rate by three-quarters of a percentage point Tuesday, it actually had no direct effect on fixed mortgages…”
Source: http://www.baltimoresun.com/business/bal-mortgage0123,0,985256.story
There is also the Discount Rate:
Dang-fangled economics classes! They sure got the general public bamboozled! :mad:
There are quite a few “economic indicator” rates. In addition to the prime rate and the discount rate, there are things like various flavors of LIBOR, a commonly used rate for setting mortgage rates, and something called the 11th District Cost of Funds, or COFI, the Federal Funds Targeted Rate, and so on.
Well of course not, a fixed rate mortage is fixed! It’s good news for those of us with adjustable rate mortgages any time the prime rate is lowered though.
The Simple Dollar has a good primer on the rate cut and how it affects the average person.
In short, the Fed wants everyone to start spending money. The rate cut encourages this in a few ways: some banks will lower the interest rates they offer on savings accounts, making that money earn less. Most banks will also lower rates they offer on loans, including mortgages and long-term car loans, making these more attractive to consumers right now. Finally, variable credit card interest rates will fall as well, making consumers more likely to use credit.
By law, each Federal Reserve Bank is required to keep a cash or cash-equivalent reserve on-hand equal to a percentage of money they have loaned out (presumably so the bank could weather a short-term run). I believe the law sets this percentage at about 10%.
Banks want to put as much money out on loan as possible–it does nothing for them sitting in the vault–so they hover their reserve as close to the legally-required percentage as possible. Day to day, a bank may even fall under this percentage; to briefly cover the shortfall, they end up borrowing money from other banks. This “overnight” interest rate is the one targeted by Fed activities.
Contrary to casual news reports, the Fed does not set this rate by fiat. If the Fed wishes to lower the rate, it will issue treasury bills; these are snapped up by investors (there are always buyers, as the risk is considered miniscule) and the cash is deposited in Federal Reserve banks. This lessens the need for overnight loans, so market forces reduce the associated overnight lending rate. It also pumps more money into the banking system, making more money available for loans, and thereby encouraging more borrowers. If the Fed wishes to increase interest rates, it reverses the process and uses reserve money to buy back T-bills.
*CJJ ** is obviously wrong. The Fed couldn’t possibly announce something as specific as a three-quarters percent drop, shovel treasury bills into the economy, and let the market come to a new equilibrium. How would anybody know what the outcome would be?
Even worse, Fear Itself posted the definition and a link earlier in the thread. The discount rate, a nickname for the primary credit rate, is a specific charge for the overnight loans the Fed makes to banks. The prime rate is pegged to the discount rate at 3 percentage points higher. You can see the prime rate’s history here. It is now 6.50%, three percentage points higher than the discount rate of 3.50%. And yes, the Fed does set this rate by fiat. That’s its job. If the news media are reporting it, that’s because they’re getting the news directly from the Fed. Here’s the press release.
The Fed also controls the issuing of treasury bills, but that has absolutely nothing to do with setting the discount rate.
Clearly I have misunderstood the federal funds rate. The description at this website has given me a better picture. A summary:
If I read this correctly, the Fed uses securities markets to set the effective overnight rate, but imposes (for all intents and purposes) a cap on interest rates by fixing a discount rate from Federal Reserve Banks. (Personal) ignorance fought!
In this case, it’s a non-technical term that the newspaper used to mean “discount rate.” It could be used for other of the various rates controlled by the Fed at the discretion of the person writing the story.
The idea is simplification: The Fed cut an important interest rate and these are its ramifications. The exact rate and what it means is not really important in this story (it may have been described in the article announcing the rate cut). In this story, the point is that a rate was cut and it caused a mortgage rush.
Economists might talk about the difference in the various rates, but for the average user and newspaper article, it really doesn’t matter.
That’s not what they’re saying, though. The point is that, even though the Fed cut the prime rate, it doesn’t mean that NEW mortgages automatically got a better rate as well. Despite that, mortgage brokers got a jillion phone calls from people who want to refi, assuming that they would instantly get a better rate because of the Fed cut.
The Fed did two things on Tuesday. Per their press release:
and
The latter action is taken by fiat. This is what Exapno is talking about. The former, as stated, is a target, which the Fed will achieve by buying Treasury bills. This is what CJJ* is talking about.
When the media talks about the Fed lowering the rate (such as the recent .75 cut) the Fed doesn’t lower the rate, it lowers its target for which they want banks to lend to each other.
They put out more or less money, thereby raising or lowering its scarcity and value.
And they are very good at it. Sometimes better than others but they get pretty close on a daily basis.
As far as the discount rate (the rate at which the Fed lends directly to the banks) this has been mostly scrapped in the last 6 weeks in favor of an auction in which the banks can anonymously bid for the rate and amount they want. The Fed doesn’t always get as much as they would like.
As far as the reserves, this has been completely corrupted over the years.
Take a look at the second table
Mortgage rates are a completely different kind of rate which are set by the price of bonds (GinnieMaes for the fixed, and LIBOR, MTA, etc for the adjustable). The fixed rates usually follow the 10 YR (symbol TNY) but not always.
More after dinner.
Sorry. The symbol for 10 year treasuries is TNX
If you would like to see a wholesale ratesheet for mortgages go Here
Its pretty simple. In each box there are 15, 30, and 45 day locks. Down the left side of the box are different rates available for that program and under each lock are the prices. Amounts in parenthesis are what the bank pays to a broker as a percentage of the loan amount. Those not in parenthesis are paid to the bank by the broker. On a 30 year fixed at 5.5% with a 15 day lock the bank would pay the broker (.250) or $250 per $100,000 of loan amount. Thats the evil yield spread.
As far as how the FED sets rates they put money into the system by purchasing securities or take money back out of the system by selling securities. You can see some of what goes on Here
As you can see the rates today were way under what they were yesterday, and way under the target rate. It seems like no one wanted to do business with them today and is effectively a rate cut they didn’t intend. This is unusual due to the whole credit crap and I’m sure they’ll get it straightened out quickly.