What the Fed can do now

[Scanner]

Raise interest rates.

Back before the interest rate cuts were being debated, I opined that instead of cutting interest rates, what the Fed needed to do was raise interest rates.

Now that oil has risen to nearly $150/barrel, they should have tuned into savingadvice.com and listened to me.

If we ever want to stimulate lending and actual interest in the US dollar (part of the reason of the rising of oil) we need to make savings and lending actually attractive again.

If Ford Motor company wants to "go solar" in their plants and needs a cool 900 million in bond funding to do that, why should, as an investor lend them my money if a bond is going to pay 5% tops?

Now, if I could lend them my money at 9%, now. . .that's another story. I may do it.

As usual, the Fed was thinking of a short term fix and it backfired.

The Fed lowered interest rates and the only thing the banks have done is use the liquid money to shore up their own balance sheets (not a bad thing per se - a good financial sheet instills investor confidence but the money was supposed to be used for lending).

I think what could possibly rescue the economy is a rally of the bond markets like we have never seen before. I beleive bonds have been kept artificially low (like commodities) the last 20 years in favor of the stock market.

In conclusion, raise the Fed interest rate and it will stimulate the economy.

Screw the foreclosures. . .we need cheap oil. Now that Americans have been dutifully shocked by high oil, I think they will finally continue to move towards alternative energy.

[Ima saver]

I agree, I think they should raise rates too!!

[atomicrc11]

Raising interest rates will only help with the price of oil since oil is traded in dollars. With a stronger dollar the price of oil would go down, and people would actually want to invest in the US.

[gamecock43]

Scanner~ I` get what you are saying. I was thinking along your lines too when I was hearing about interest rate cuts. But I kind of get lost in logistics and stuff. I have a hard time understanding the "process" of money and what it does. Can you help me out? Here is what I "think" happens:

Ford Motor Company decideds to go Solar. They need 900 million to do it. (using your example) Average American invests in Ford Stocks on a given day and Ford receives $10,000 in their bank account to do business with.
Ford decides to take the 10k and start the solar process....
Years pass and Ford is working on it's Solar process....
Average American decides they want their 10k back.
(Heres what I dont understand)
Average American withdraws their 10k + interest. Who pays the "interest" part?
Ford? Did they assume they would be able to pay back what was invested and then some when they took the money?
Other average Americans who recently decide they want to invest in Ford but invest at a higher price and now Ford has the money to give the first person their money and interest back?
I dont get it. I dont even get if what I dont get makes any sense. Capiche?

[jIM_Ohio]

I think we will see rates rise after the election. Long time coming.

It will cause more real estate issues, but the other parts of the economy should benefit.

[Scanner]

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Scanner~ I` get what you are saying. I was thinking along your lines too when I was hearing about interest rate cuts. But I kind of get lost in logistics and stuff. I have a hard time understanding the "process" of money and what it does. Can you help me out? Here is what I "think" happens:

Ford Motor Company decideds to go Solar. They need 900 million to do it. (using your example) Average American invests in Ford Stocks on a given day and Ford receives $10,000 in their bank account to do business with.
Ford decides to take the 10k and start the solar process....
Years pass and Ford is working on it's Solar process....
Average American decides they want their 10k back.
(Heres what I dont understand)
Average American withdraws their 10k + interest. Who pays the "interest" part?
Ford? Did they assume they would be able to pay back what was invested and then some when they took the money?
Other average Americans who recently decide they want to invest in Ford but invest at a higher price and now Ford has the money to give the first person their money and interest back?
I dont get it. I dont even get if what I dont get makes any sense. Capiche?

First of all. . .I don't want to be pretentious to say I am a Ben Bernacke or an Alan Greenspan but let me clear up one thing - you are confusing the equity sector with the debt sector.

If Ford Motor Co. needs 900 million to put solar panels on it's rooftops across the county. . .there are two ways it can go about it.

It can take stockholder money. Stockholder money is when you buy stock and give it to Ford and they can do whatever they want with it. They can have it go towards a CEO salary, employee salaries, a gold fountain in the lobby, whatever. In this case, they can have it go towards solar panels, if the CEO decides it.

Or it can issue a bond. Bonds are a partially or non-secured debt. In essence, it's a loan. So. . .they could issue $5000 bonds and I send it and get interest every month or all at once (zero coupon) when the bond (loan) matures.

You usually (from what I know) can't call a bond early, just like your mortgage co. can't call it's loan early. The best you can do is a sell a bond on the bond market if you want to dump it.

Here's the rub.

If there are problems (bankruptcy, Chapter 11) - bondholders are paid first. . .stockholders second.

That's always true.

Because the bondholder is a lender. . .not an owner, like a stockholder. Nobody cares about the owner. But to do business in America, you want your lenders paid first.

So. . .if Ford goes under while trying to "go solar", they sell off their SUV's and pick-ups and gray cubicles at auction and the monies are disbursed to bondholders first, after the lawyers get their cuts of course.

Stockholders never see their money. It's gone. Ford is now worth about .03/share.

Our economic policy since Reagan has been to essentially pump up the stock market (speculation) and depress the bond market ala interest rates. I don't think that has been to America's benefit at all times and we are seeing some consequences of this.

[gamecock43]

ohhh...things are becoming clearer at the same time they get muddier in my head!
So it is always SAFE to get a bond, but the interest rate is reletively low.

It is not always SAFE to get a stock in that company but there is no "fixed" interest rate so the ruturns CAN be very high.

And the fed govt determines the interest rate for money that is loaned.

Do bond interest rates have the same interest rates as mortgages? I know that when the fed made an announcement about cutting interest rates earlier this year, mortgages interest rates were lowered to entice new homeowners, and in turn my savings account interest rates went down because the banks were not collecting high inteerest rates on their mortgages anymore. So its all connected, right?

And Scanner- I asked you a question about your "blue chip" idea too. If you have time, I would love for you to elaborate on that as well.

[gamecock43]

never mind, I read about the blue chips thing after this post. Thanks for clearing it up!

[disneysteve]

we need cheap oil. Now that Americans have been dutifully shocked by high oil, I think they will finally continue to move towards alternative energy.

I disagree. I think Americans are only starting to pay attention to conservation and alternative energy because the price of oil/gas is up. If the price comes back down, folks will go right back to their previous wasteful ways. The only thing that will cause continued conservation is continued high prices.

[jIM_Ohio]

When vorporations issue bonds, they will pay higher than treasuries to account for default risk. (Higher risk is higher reward).

If interest rates are 2% for fed- this is the rate banks charge each other to borrow money from each other (short term). Lower=more liquidity.

At same time bonds for treasuries will pay between 3-5%. I have not looked recently at what treasuries pay, I am guessing about 4% because money markets are slightly less than that. Corportate bonds would be paying 5%-100% depending on credit rating.

As rates go up, all these rates increase.

[gamecock43]

Eventually the oil will be gone. Why not just move off it now while we can take our time with the transition. Imagine what the world will be like 5 yrs before the oil is gone? A total warzone. At least if America is 75% off oil, then we can be like Canada and stay out of things.
*I say this but I just bought a new SUV a few months ago* oiy.

[maat55]

I think this is a necessary stomach ache. I don't see where higher interest rates help the overall economy. Like DS said, people are having to take notice our energy problem.

Becausee I'm debtfree and living on a lower monthly expense plan, I'm weathering this ok, even with my business slowing down. I don't wont it to last too long, but I do want to see some substantial changes made that will help our longterm outlook. Just my 2 cents.

[Scanner]

ohhh...things are becoming clearer at the same time they get muddier in my head!
So it is always SAFE to get a bond, but the interest rate is reletively low.

Change that to "safer" (principle risk) and you are dead on.

It is not always SAFE to get a stock in that company but there is no "fixed" interest rate so the ruturns CAN be very high.

You basically got it. There really is no "rate of return" on a stock. A stock just says you own something. The "rate of return" could be considered a dividend but not all companies pay dividends with the profit they make. Most companies prefer to roll it back into growth of the company (which drives up price share).

This is the fundamental difference between a "growth stock" and an "income stock" (like a utility).

So, now you know when you see Vanguard Income and Vanguard Growth what the mutual fund managers are seeking.

And the fed govt determines the interest rate for money that is loaned.

Kinda . . .see JimOhio's post.

Do bond interest rates have the same interest rates as mortgages? I know that when the fed made an announcement about cutting interest rates earlier this year, mortgages interest rates were lowered to entice new homeowners, and in turn my savings account interest rates went down because the banks were not collecting high inteerest rates on their mortgages anymore. So its all connected, right?

It's all connected but the mortgage rate didn't drop right away. It has to "filter down" for awhile. It's just the rate that banks loan each other money so they can "sell loans."

If they don't sell loans, they don't make money.

[gamecock43]

Thank you! I am learning slowly.

[disneysteve]

There really is no "rate of return" on a stock. A stock just says you own something. The "rate of return" could be considered a dividend but not all companies pay dividends with the profit they make.

When a stock does pay a dividend, you will see it reported that the stock has a dividend yield of X%, but even that is a bit deceiving because the stock price fluctuates while the dividend payment stays the same (unless the company changes it) so that yield also fluctuates.

A stock with a high dividend yield might not be such a good thing either because the yield may be high because the stock price has been falling and they haven't adjusted the dividend yet. Take a look at Bank of America (BAC). It has a current dividend yield of 12.7%. Sounds like a fantastic investment, right? The problem is the stock price has fallen from $53.00 to $20.00 in the past year and may fall even lower. Chances are that the company will cut that dividend in the near future if they don't have the earnings to continue to support it.