- The Washington Times - Wednesday, March 19, 2008

Yesterday, for the sixth time in six months, the Fed reduced its benchmark short-term interest rate, slashing the federal-funds rate by three-quarters of a percentage point and lowering it to 2.25 percent. With consumer prices now rising at an annual rate of 4 percent, the real (i.e., inflation-adjusted) fed-funds rate is now a negative 1.75 percent, confirming that monetary policy has become extremely expansionary as the economy flirts with recession while trying to overcome one of the worst credit crunches since the Great Depression.

For the second time in less than two months, the Fed has reduced its policy rate by three-quarters of a percentage point. Both actions matched the largest incremental cut since the central bank began conducting monetary policy by focusing on the fed-funds rate more than 25 years ago. Despite this historically aggressive action, however, many on Wall Street were disappointed. They had hoped for a full-percentage-point cut in the wake of the weekend collapse of Bear Stearns, the nation’s fifth-largest investment bank.

The Fed also chopped three-quarters of a point off its discount rate, lowering it to 2.5 percent. The discount rate is the interest rate the Fed charges banks that borrow directly from the Fed’s “discount window.” On Sunday night, the Fed cut the discount rate by a quarter-point when it announced that the Federal Reserve Board had unanimously voted to allow the roughly 20 investment banks that serve as securities dealers for the Fed to begin borrowing from the discount window. Before Sunday’s dramatic announcement, only commercial banks could borrow from the Fed.

Indicative of the increasing strain in the housing and credit markets, the interest rate for a 30-year fixed-rate jumbo mortgage has increased from 6.01 percent to 7.02 percent during the past year, while the interest rate for the 10-year Treasury note has fallen 1.3 percentage points. That means the crucial spread between the 10-year Treasury note and a jumbo mortgage has soared from less than 1.5 percentage points a year ago to nearly 3.75 points today. Jumbo interest rates apply to mortgage loans above $417,000. In high-priced housing markets, the prevalence of jumbo mortgages and the gaping spreads between jumbos and 10-year Treasuries have greatly contributed to falling home prices, which has exacerbated the worsening credit crisis.

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