Tuesday, March 18, 2008

Fed cuts rates by 3/4 of a point

The Federal Reserve slashed its federal funds rate, an overnight bank lending rate, three-quarters of a percentage point Tuesday, to 2.25% in the central bank's continued effort to restore confidence in the economy and battered financial markets. It is the sixth cut in the past six months and comes at a time when the Fed is trying to keep the economy from slipping into recession - although many think it's already entered one.

In an interesting article in Fortune Magazine (March 3, 2008) written by Stanley Bing, the author wonders what would happen if interest rates were lowered all the way to zero.

In the past, it's been my opinion that noting else could be done. Using the example of pushing a string, there is simply no more the government can do in order to stimulate spending. Heck, if money is free but there are still no takers, what can you do?

Mr. Bing proposes negative interest rates - a proposition I find quite interesting. In effect, the government pays you to take money. It's not as bizarre as you think. Take the soon to be distributed economic stimulus checks that should start arriving in Americans' mail boxes in May. In effect, the US Government is giving away free money. Under the negative interest rate scenario, rather than sending $600 to every tax paying American, the government would instead subsidize interest rates to banks. Banks could offer to lend money, with a 2% extra cash bonus. But the government would pay the banks 4% - a 2% return - in order to subsidize the borrowing.

Under this plan, only the most credit-worthy borrowers would be able to take advantage of the plan. People who did not need the money would not automatically receive it. The best part about this plan, it might actually cost less than sending every US tax payer $600. For example: If I was a borrower in need, and took advantage of a stimulus package loan of $5,000 and agreed to pay it back in two years, the 4% subsidy from the US Government would only be $400. If the loan was subsidized for 3 years, the cost would be $600, and if the government agreed to a 4 year term, the cost would climb to $800. Not everyone would be able to borrow $5,000, though. Some might borrow more, but most - less.

Of course, the downside is that we could run out of money. But, as the author suggests, we just print more. Don't we?

Tomorrow: Why it's becoming painfully obvious that we're in this recession for the long haul.