Wall St. and Business Wednesdays: E-Letter To Ellen McGirt and CNBC Re: What Federal Reserve Monetary Policy Means To The Masses
I have been meaning for three weeks to write you and tell you how very much I deeply appreciated the commentary you provided on CNBC, immediately after the last Federal Reserve rate hike - its 16th in a row - was announced on May 10th.
I sat back comfortably in a love seat and gave you mental standing ovations as you made succinct point after succinct point under obviously tight time constraints - on both your preparation and presentation. As I watched you, I thought to myself, “this Sister is saying something almost anyone in this country could relate to.”
It is your ability to make the complex plain and current events applicable to the personal lives of the masses that we value at Black Electorate Economics University (BEEU). For that reason we will be paying close attention to all of your published writings – at Fortune magazine, Money magazine, and elsewhere – in our Second Semester, “Personal Finance – Financial Literacy and Turning Money Into Wealth”
For the benefit of our readers, those interested in BEEU, and in an effort to spread the word about you, I would just like to publicly go over the points you made that day, and add some points of my own. Here are the four areas that you showed were so relevant to the Federal Reserve’s decision to raise the federal funds rate by a quarter of a percentage point:
Adjustable Rate Mortgages. You noted that with the Federal Reserve raising interest rates, those individuals with adjustable rate mortgages (ARMs) are finding themselves in increasing vulnerability as their monthly payment are subject to rise due to the relationship between their mortgage payment option and short term rates. I agree and can tell you of individuals that I am learning about who refinanced their homes taking an option ARM of under 2% thinking they were locking in that low mortgage rate for as long as five years. How wrong they were. They were only able to enjoy that low rate for two months before their monthly statement showed they owed 4%, and eventually, within months, 7%! If that were not bad enough they have even seen their overall loan balance grow by a couple of thousand dollars. No wonder the demand for ARMs dropped by 25% last fall, and folks are looking again with affection at the 30-year fixed-rate mortgage, and even ‘hybrid’ ARMs, which remain fixed for up to 10 years before they adjust annually. The complexity of ARMs, the fact that some lenders have raised their price for new home owners, and the environment of rising short term rates - courtesy of the Fed - will continue to cause this once hot financial instrument to decline in popularity.
Credit Cards. You stated that consumers should be mindful of the relationship between their credit cards and interest rates. You could not be more correct. So many people do not understand that term “APR,” for instance, which their credit card issuer discloses and includes in the contracts and agreements every credit card user or customer signs or ‘ok’s. APRs (the annual percentage rate) are the way of stating the interest rate a person will pay if they carry over a balance, take out a cash advance, or transfer a balance from another card. The APR states the interest rate as a yearly rate. Well, there is not just one kind of APR. There are fixed, variable, tiered, delayed, and introductory. A single credit card might have these various kind of APRs. There are fixed and variable APRs, and it is the variable ones that are tied to other interest rates like the prime rate or 91-day Treasury Bill rate, which are influenced, no surprise, by the Federal Reserve’s control over the federal funds rate. Believe it or not, the Fed actually has one of the best web pages to consult when comparing and contrasting credit cards.
Student Loans. This I thought was the most interesting of all you had to say. You stressed that beginning in June of this year the Department of Education would be changing the interest rates it charges for certain loans it makes to college students and that these were influenced by Federal Reserve interest rate decisions. You are absolutely correct. It is the federally subsidized Stafford loans and Parent Loans for Undergraduate Students, or PLUS loans that you were referring to. The interest rates for these loans are pegged to the 91-day U.S. Treasury bill rate, and are now, going up by about 2 percentage points. Yesterday, May 30th, the Department of Education made that official – with the changes taking effect on July 1st. Interest rate hikes and cuts by the Federal Reserve’s Open Market Committee (FOMC) are what result in corresponding increases and cuts in education loan interest rates. This fact alone should cause every parent and child in this country considering higher education to take note. As an interesting side note - have you heard of the controversy over ‘school-as-lender’ arrangements and noticed that more and more colleges are getting into the loan business themselves – extending credit to students directly, cutting out the middle man. Why? These institutions have realized - like automobile companies decades ago - how profitable this business can be, especially in an environment of higher interest rates, and the increasing importance of the graduate degree. Just think, graduate students borrow on average $32,000 beyond their undergraduate debt. In 2003-2004 schools made more than $1.5 billion in loans. The Federal Reserve’s interest rate decisions have implications on the growing competition between banks, the government, and schools who want to lend to students.
CDs and Savings Accounts. As you mentioned, not all news associated with the recent Federal Reserve rate hikes is bad for consumers. An investment vehicle that many financial advisers have believed to hardly not even be worth mentioning – the savings account – is getting the time of day again. As a consequence of the Federal Reserve raising interest rates, the rate on savings accounts has steadily climbed with it. As you mentioned on CNBC, the also forgotten certificate of deposit (CD) is now also increasingly attractive for those looking to get a return on their money in a relative safe way, in a short period of time (for 90 days or 6 months, for example). For those who want a measure of liquidity and security in an investment they can understand, CDs are coming up more and more in conversations related to financial decision-making. Thanks to the Fed, their rates are the highest they have been in sometime.
Its exercise of its control over the Federal funds rate is the Federal Reserve’s third most powerful weapon in its arsenal. We get into the other two at BEEU. But the Federal Funds rate, its impact - which you demonstrate, and the mechanics of how it is influenced are so instructive for those looking for the intersection between finance and economics. On this last point, regarding the mechanics of exactly how the federal funds rate is influenced by Fed policymakers, I hope that you will read my E- Letter to Dr. Irwin Keller in the year 2001. A professional money manager who is a member of BEEU told me it was the clearest explanation he had ever read of the process.
For nearly 15 years I have been paying attention to virtually any piece of information that comes my way regarding the Federal Reserve System. It is to the American economy what the circulatory system is to the human body. It affects everything – directly or indirectly - having to do with money in this country.
Your article provides a great snapshot bearing witness to this reality.
Keep up the great work. It is appreciated.
Wednesday, May 31, 2006
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