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Personal Finance Blog By MoneyRates - January 2012

State of the Union: Good or bad for savers?

January 25, 2012

| MoneyRates.com Senior Financial Analyst, CFA

After four years of economic weakness, the 2012 election may well hinge on how voters feel about Washington's handling of the economy. For his part, President Obama tried last night in his State of the Union speech to make the case that his administration is up to the challenge of reviving the nation's finances.

But since the last election, depositors in savings accounts, money market accounts, and CDs have seen their interest rates dwindle to virtually nothing, meaning that savers are sure to be among the frustrated constituencies of the next election.

The question is, who will they blame more: President Obama, who has failed to get the economy up to speed, or the Republicans, who played a bigger role in creating the economic mess than they have in trying to solve it?

For the benefit of bank depositors, here is a summary of how some of the President's major proposals could affect CD, savings, and money market rates:

  • Corporate tax reform. The President suggested rewarding companies that create jobs in the U.S., while punishing those who use foreign workers. That populist tone will play well to many ears, but represents the type of interference that can hamper growth and raise prices. Net effect on savings accounts: negative.
  • Foreign trade. Protectionist talk is always a good way to get votes, but it is also a good way to fuel inflation. Net effect on savings accounts: negative.
  • Infrastructure projects. Well-placed infrastructure projects can create jobs in the short-term, while helping commerce operate more efficiently in the long-term. Net effect on savings accounts: positive.
  • Mortgage assistance. The President proposes to charge large financial institutions a fee to fund a refinancing program designed to help home owners keep their houses. As nice as that sounds, the business reality is that customers of those banks will ultimately have to absorb the cost of those fees. So if you are not one of the people receiving this mortgage assistance, you could well end up paying for it in the form of higher bank fees or lower interest rates. Net effect on savings accounts: negative.
  • Bank regulation. Bashing bankers will probably remain a popular tactic for years to come, but there is a cost to it. On top of the new Consumer Financial Protection Bureau, Obama announced a special Financial Crimes Unit. This sounds like crossing the line from reasonable protection to piling on costs. Net effect on savings accounts: negative.
  • Personal tax reform. There is an increasingly narrow constituency for protecting the wealthiest taxpayers at the expense of tax reforms and lower tax rates for average earners. Because lower earners have a higher marginal propensity to spend, the President's proposal should help the economy. Net effect on savings accounts: positive.

Perhaps the most useful asset you have in making your decision about the election is the several months of time left until you cast your vote. With the economy seemingly at a turning point, whether it can generate any lasting momentum may well decide the outcome of November's contests.

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Is recent mortgage activity a win for the Fed?

January 24, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Mortgage applications surged in the second week of January, responding to record low mortgage rates. The Federal Reserve's Operation Twist aimed to make security purchases that would drive mortgage rates down to support the housing market, so does the recent mortgage activity mean it's working?

You have to give the Fed partial credit on this one. While the record low level of current mortgage rates may not have turned the housing market around yet, it does appear to be helping.

Record low mortgage rates spark new activity

During the second week of January, 30-year mortgage rates reached a new low of 3.89 percent. Having spent all of 2011 below 5 percent, mortgage rates would already have been considered very low by historical standards, but since the middle of last year they've made a new push downward. Mortgage rates dropped below 4 percent for the first time in November, and current mortgage rates are more than half a percent lower than they were in mid-2011.

Mortgage demand has responded to these increasingly attractive rates. According to the Mortgage Bankers Association (MBA), their seasonally-adjusted index of mortgage application activity jumped 23.1 percent in the second week of January.

This figure doesn't directly translate to the actual level of new mortgages being written -- not all applications are approved, and people anxious to snap up a low rate might submit multiple applications. Still, as a general indicator of interest in mortgages, the MBA figures are a useful gauge, and right now that gauge suggests that people are responding to record low mortgage rates.

Refinances drive the numbers

There is a catch though. All this mortgage activity does not represent a surge of new buyers flooding into the housing market. While refinance applications jumped by 26.4 percent in the second week of January, new purchase applications rose just 10.3 percent. Refinance requests represented 82.2 percent of total mortgage applications, the highest portion in over a year.

In short, most of the recent mortgage activity does not represent new demand for housing. Instead, people are responding to the fact that refinance rates have fallen far enough that even those who bought homes after the housing bubble burst can now lower their costs even further by refinancing.

True support for housing

There is a cautionary element even in the 10.3 percent jump in new purchase applications. Housing demand may be overly dependent on artificially low mortgage rates. The question is, once the Federal Reserve runs out of tricks for pushing mortgage rates down, how much housing demand will remain?

Still, there is reason to cheer recent mortgage activity. The surge in refinancing represents a new wave of people who are able to save money on mortgage payments. That frees up part of their monthly incomes for spending elsewhere. It is new sources of spending that can launch the kind broader economic recovery that would provide sustainable support to the housing market.

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What the improving health of banks means to you

January 17, 2012

| MoneyRates.com Senior Financial Analyst, CFA

There were 92 bank failures in the U.S. last year. Five years ago, that number might have seemed shocking, but it's a sign of the recent times that this total represents a distinct improvement.

Last year's 92 bank failures represented a 41 percent decline from 2010's total, and marked the first time since 2008 that the number has been under 100. What is even more impressive is the improvement in the amount of deposits affected. This has declined year-by-year: from $234 billion in 2008, to $138 billion in 2009, to $78 billion in 2010, and finally to $31 billion last year.

That's not just good news for banks and their shareholders. Every participant in the banking system, such as depositors in savings accounts, mortgage borrowers, and businesses seeking loans, has a stake in the health of that system.

The new normal?

Does this mean things are getting back to normal? That depends on what you define as normal. For example, in 2007 there were just three bank closings, affecting a little more than $2 billion in deposits. That's what a truly quiet year looks like.

On the other hand, the industry has seen worse periods for closure activity than even the past four years. Due largely to the savings & loan crisis, the decade from 1983 through 1992 produced 2,242 bank failures, or an average of 224 per year. It's a reminder that no one -- not banking executives, legislators, or consumers -- should ever take the health of the banking industry for granted.

What's in it for you?

So why do you care if some banks go out of business? After all, your bank may not have been affected, and you are protected by FDIC insurance anyway. Even so, here are four ways fewer bank closings could benefit you:

  1. Stability. FDIC insurance or not, having to change banks would be a nuisance, especially if you had to do it under duress.
  2. Service. When banks are having financial trouble, service is one of the first things to be cut. This includes telephone representatives, branches, and customer perks. The healthier banks are, the better the service you are likely to receive.
  3. Interest rates. When banks are weighed down by financial setbacks and rising FDIC insurance assessments, they can't afford to pay as much interest on CDs, savings, and money market accounts. If you want to see higher rates, root for healthier banks.
  4. Availability of loans. The rash of bank failures has largely been due to bad loans, and when banks are burned by defaults, they are less likely to lend new money. As the health of the banking system improves, loans will be more readily available to individuals and businesses.

The drop in the number of bank closures -- and in particular, in the amount of deposits involved -- during 2011 was a step in the right direction. But the industry will have to build on this momentum in 2012 for conditions to truly feel normal again.

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New Fed forecasts: Transparency or distraction?

January 11, 2012

| MoneyRates.com Senior Financial Analyst, CFA

As part of Ben Bernanke's commitment to increasing the transparency of the Federal Reserve decision-making process, the Fed will begin releasing regular forecasts of interest rate expectations. While the goal is to give more weight to Fed decisions by trying to manage investor expectations, there is a possibility the move could backfire.

Regardless of what the Fed does, interest rate markets will remain anticipatory by nature. The problem is, when the Fed forecasts future changes in interest rates, it may spark an anticipatory reaction by the financial markets that undermines current interest rate policy.

Influencing behavior

On January 3, the Fed released details from its December meeting that included plans for the new forecasts. These forecasts will show the range of predictions made by Fed officials regarding the level of short-term interest rates over the next three years. The first of these forecasts is scheduled to be released on January 25th.

These forecasts could well influence investor behavior. For example, a forecast of extended period of low interest rates could influence bond market investors to buy longer-term bonds. Similarly, bank customers looking at such a forecast might be more inclined to lock money up into 3-year CDs, rather than keeping money in savings accounts or money market accounts. The idea would be to capture the higher rates associated with long-term CDs, rather than retaining the flexibility of savings accounts during a period when interest rates are not expected to change much.

Unintended consequences

At best, the Fed's new forecasts might aid financial decision-making, and reinforce the impact of Fed policies. However, there are some unintended consequences that could hurt both investors and the Fed's mission.

For example, what if the Fed forecasts rate stability, but then is forced to raise rates in reaction to changing conditions? Will it lose credibility among investors and bank customers who have made decisions based on the original forecasts? Will the Fed be under public pressure to adhere to its original forecasts, thus slowing its ability to adjust policy to economic conditions?

Also, the Fed has made the decision to release these forecasts at a time when it clearly expects an extended period of low interest rates. If investors use these forecasts as a guide, the effect should be to reinforce the impact of the Fed's low interest rate policy. However, what will happen when the Fed starts to forecast rising interest rates a year or two out?

Again, markets are anticipatory, so once the Fed begins to forecast higher interest rates in the future, bond yields may start to rise immediately. This would counteract the effect of the Fed's current interest rate policy. In practice, could be very difficult for the Fed to forecast future changes without those forecasts starting to impact immediate policy.

In short, the Fed's job is tough enough as it is. Releasing detailed interest rate forecasts is an unnecessary complication that might only make that job tougher.

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The downside of low mortgage rates

January 4, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Just before Christmas, two announcements seemed to herald a recovery in the housing market. However, just as with all the inflatable Santas cluttering lawns in December, the air might be out of the hopes for housing recovery before we get far into the new year.

On December 21, the National Association of Realtors (NAR) announced that existing home sales had risen in November -- up 4 percent over October's figure, and up 12.2 percent year-over-year.

The next day, Freddie Mac announced a new record low for 30-year mortgage rates - 3.91 percent.

On paper, this could make it appear that the housing recovery is shaping up as planned: lower interest rates create new housing demand, which fuels a recovery in sales and housing prices. However, a closer look at the numbers doesn't support that optimistic view.

A closer look at home sales

The NAR press release points out that existing home sales in November were at a 10-month high, up 4 percent from October, and up 12.2 percent over the prior November. All of this is true, but the numbers still don't add up to a picture of a robust recovery in housing. After all, consider these three other facts:

  1. While existing home sales have recovered in recent months, they are still below the level at which they started the year.
  2. The 12.2 percent year-over-year increase may be helped by the fact that last year's figures were recently revised downward by 14.6 percent.
  3. At $164,200, the median price for existing homes is down 3.5 percent from a year ago.

Housing sales plunged in 2007 and 2008, and since then have been in more of a holding pattern. While it is fortunate that the sharp decline has leveled off, it would still be premature to call this a recovery.

The question is, why has a recovery taken so long to materialize? After all, home prices are down, and current mortgage rates are at record lows. Basic economic theory says that lower costs should stimulate demand. Is the problem simply that people are still scared off by the housing slump?

Are current mortgage rates scaring off banks?

Another possibility is that it is bank executives, not prospective home buyers, who are scared off by the housing market. The reason might be those record low mortgage rates.

After all, signing up for a 30-year mortgage isn't just a commitment by the home buyer. It is also a commitment by the lender. At current mortgage rates, that means committing to 30 years of record low interest, at a rate below the long-term rate of inflation over the past 50 years.

That's hardly a compelling business proposition. At best, it means banks aren't marketing mortgages with their prior enthusiasm, and at worst, it means banks are making it more difficult for qualified buyers to get a mortgage. Either way, it helps explain why home sales have been slow to respond to lower mortgage rates.

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