Who has heard the expression “dropping your pants”?
Everyone. Thought so.
Well, that’s what the Federal Reserve has done this morning. It has taken the momentous decision to drop the Fed Funds Target Rate to a maximum of 0.25%. Almost everyone expected them to do that, so that part of it wasn’t a surprise.
The big surprise was what else they have done with the rate. Having seen that the market was pricing interest rates well below the target rate, the Fed has thrown up its hands.
Instead of setting a specific rate, such as the 1% that it was before, the Fed has set a ‘range’ of 0%-0.25%. In effect they are challenging the market to take the rate down to zero.
The Fed conveniently publishes the daily rates on its website for all to see. You can see a snapshot of it below:
Even before the rate cut, the market was trading well below the 1% level. Chances are that over the next few weeks we will see the rate drop to zero. In which case the only option left for the Fed is to print money, and the inflation race begins again.
But that wasn’t all the Fed had to say. No, there was much more.
The press release states:
“As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.”
In other words it is going to take the place of the discredited and dysfunctional Fannie Mae and Freddie Mac. Only this time it is upping the ante by not just providing capital for the mortgage market but it will also provide capital households (credit cards and car loans we presume) and small business.
But that wasn’t the end of its generosity either…
The Fed’s Hidden Gift to US Banks
We aren’t sure if this final gem from the Fed was shuffled out quietly into the market or whether they had always intended to make the announcement today.
First a bit of background. As you may be aware, banks have to maintain something called ‘Tier 1′ capital. In simple terms it means they need a certain percentage of liabilities backed by hard assets – usually government bonds or foreign exchange reserves. Australian banks have been raising capital recently to keep their Tier 1 at around 8%.
Well, news from the US Fed this morning is that US banks are now able to be more flexible with their Tier 1. The new rule means they no longer have to discount goodwill from the calculations for Tier 1.
In other words, banks can now use intangibles such as the value of a brand name as ‘hard’ capital against its liabilities. In effect, the Fed is moving the goalposts. It is saying that it knows the banks are up a certain creek, so rather than call them out on it; it is changing the rules so that the banks can look stronger than they actually are.
As our Diggers & Drillers colleague Al Robinson said, “They can finally put a value on happiness – $1 squillion, add that to the balance sheet please!”
Money Morning Mail Bag
Time for some reader mail on our thoughts on Telstra yesterday…
Nice MM article sir,
But personally I’d split Telstra up into “Infrastructure” and “Service”. That way you have a truly independent company that is responsible for all of the infrastructure, all those pesky copper wires etc, which would still be answerable to the government as it is now.
And then you have a separate service company that goes head to head with Optus & Vodafone etc in the telecommunications space and would be a truly private company.
This model would mirror what happened in the UK in the rail space. They split it all up, sold it all off and you now have one company that looks after the infrastructure and lots of private companies competing to run the services on them, makes for healthy competition and does not allow one company to have a stranglehold over the entire offering.
In general I think Telstra’s approach has been quite arrogant, they haven’t bothered to submit anything (of substance) because they know that it can’t be built without them anyway as they own it all. Massive conflict of interest from them, so let’s split them and get some healthy competition going.
Ho hum, inefficient markets here we come!
Keep up the good work,
Macca
If they had done that prior to privatisation I wouldn’t have a problem with Macca’s idea.
The trouble is I would have a BIG problem with a government forcibly breaking up a private company. Imagine the precedent, the government stepping in to any business and doing what it likes.
“Erm, sorry Bakers Delight, we think you have too many bread shops, we order you to sell some of them to Brumby’s…”
In actual fact, that does already happen under the auspices of the ACCC. Forcing a break up of Telstra would bring government interference into the mainstream.
Really what needs to happen is for the government to keep its nose out (why is it even involved with setting up a broadband network anyway?!) and let real competition prevail. It may involve higher prices to begin with (for consumers) as telcos invest in infrastructure, but eventually it would lead to lower prices as more competitors are drawn into the market.
Unfortunately, when government gets involved in industry it just leads to higher prices. And less competition. Mainly because it creates too many barriers to entry – ie. Why would a company now try and set up a rival broadband network when it knows it is competing against the deeper pockets of government?
That is why government intervention in anything always hinders competition.
Cheers.
Kris.