WHILE THE FEDERAL RESERVE'S move to cut the Fed Funds rate by 50 basis points gave Wall Street a positive jolt on September 18, it probably did very little to spark job growth, economic growth, or turn around the nightmare builders find themselves in.
While many ARMs are tied to the London interbank offered rate (LIBOR), plenty are tied to short-term rates in the U.S. that the Fed can impact. Fixed rate mortgages are tied to long-term treasury rates that will not be impacted by the Fed's rate cuts.
So some people seeking ARMs or to refinance could see some benefit due to the lower short-term rates, as banks have access to money more cheaply, says Christian Weller, senior fellow at Center for American Progress and a professor at University of Massachusetts Boston.
But what if consumers again seek ARMs, thinking only about the more affordable short-term rate and not the adjusted rate they will have to pay eventually?
“That may be one of the unforeseen consequences of this rate cut, that we basically recreate a problem we're trying to get rid of,” Weller says. “You're trying to fight fire with fire at this point.”
Another flammable situation facing home builders is falling house prices. According to a new report by Moody's Economy.com, 49 of the largest 100 housing markets will see price declines from their peak of at `least 9 percent in coming years, with some markets hitting 25 percent reductions.
That could mean real trouble for the economy, because as prices decrease, so do the incentives for builders to put up new product, Weller says.
“That means you're going to see continued weakness across the economy, because you're going to see layoffs in the construction sector, and that's how the problem can spread well beyond simply the subprime market,” Weller says. “Once the price cuts come, the sales of new homes will go up a little bit, but it's a question of whether the volume of sales increases as much as the price goes down.”