Fed rate cuts will not help Financial stocks much

Mike Larson takes a closer look at how the Fed rate cuts are affecting the financial stock markets. Mr. Larson examines the myths and truths of these rate cuts.

Some mortgage holders will not see as large an increase in the rates and payments on their adjustable rate mortgages because funds rate reductions are lowering the London Interbank Offered Rate that many such mortgages are tied to. Rates on home equity lines of credit will come down as well. That's because they're tied to the prime rate, which essentially mirrors changes in the Fed funds rate. Unfortunately, the rate cut also comes with a long list of major negatives:

For one thing, savers will get hit again. Rates on Certificates of Deposit and money market accounts will likely fall in the wake of the latest cut. For another, the cuts will not help falling home prices. Rate resets aren't the only threat to mortgage borrowers and loan performance right now. Falling home prices are a much bigger deal. The more home prices fall, the further underwater borrowers become and the more incentive borrowers have to just give up and walk away from their loans. The latest S&P/Case-Shiller report showed prices falling 7.7% from a year ago in November. That's the worst drop on record. Overall, prices were down in 17 of the 20 metropolitan areas the firm tracks. And even cities that were reporting nice year over year gains are starting to fade. The National Association of Realtors' figures show the same general trend, the median price of an existing home fell 6% in December vs. the same month a year earlier. And there's more bad news for new homes. The National Association of Realtors' figures show prices fell 10.9%, the sharpest decline in any month since 1970.

The fashionable thinking on Wall Street is that these Fed cuts will restore bank profitability and allow major institutions to put the financial crisis behind them. These cuts will help firms pick up some extra interest income because long term interest rates will move higher relative to short term rates. But unlike past financial crises, and their Fed-fueled recoveries, it's not just one category of loans causing all the problems. Nor is this just an isolated hedge fund blow up like in 1998 with long term capital management. Instead, delinquencies could rise in many categories of loans:

- Mortgage defaults and foreclosures have been soaring for a while.

- The delinquency rate on fixed term home equity loans is the highest since late 2005.

- The delinquency rate on revolving home equity lines of credit is the highest since late 1997.

- The delinquency rate on prime credit auto loans is higher than it was in 2001 when the economy was last in recession.

Plus, write-downs are coming from everywhere and the value of complex debt securities that banks are holding on their books is slumping fast. Standard & Poor's just put out a report suggesting losses from subprime-related mortgage securities could top $265 billion at regional banks, credit unions and other financial firms. S&P also either cut ratings or put its ratings on review for a whopping $534 billion worth of mortgage bonds and so-called collateralized debt obligations (CDOs).

That's roughly half of all the subprime bonds S&P rated in 2006 and early 2007.

"Many banks and brokers are also stuck holding tens of billions of dollars of leveraged loans, financing used to fuel the recent corporate takeover boom. Those loans are also losing value. Bloomberg recently reported that banks are stuck with a $230 billion pile of high-yield, high-risk debt. That includes $160 billion of leveraged loans and $70 billion of junk bonds. Meanwhile, a basket of loans that S&P monitors recently traded down to about 91 cents on the dollar," Mr. Larson states.

To read this issue online, please visit:

http://www.moneyandmarkets.com/Issues.aspxFed-Rate-Cuts-Will-Not-Help-Financial-Stocks-Much

About Mike Larson and Money and Markets

Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.

Before joining Weiss Research, Mr. Larson was a personal finance reporter for Bankrate.com where he wrote extensively on mortgage lending, banking, residential real estate, and Federal Reserve Board policy. His responsibilities included analyzing economic data and interest rate trends for a weekly column and developing rate forecasts for a regular index feature. Previously, Mr. Larson held positions at Bloomberg News and the Boston Herald.

Recognized as an interest rate and mortgage market expert, Mr. Larson's views have been quoted in the Washington Post, Chicago Tribune, Dow Jones Newswires, Reuters, Sun-Sentinel and the Palm Beach Post. He has also appeared as an investment expert to discuss the housing market on CNBC, CNN, and Bloomberg Television. His writing has been acknowledged by both the National Association of Real Estate Editors and the Massachusetts Press Association.

Among the first analysts to call the housing slide, Mr. Larson's new policy paper, "How Federal Regulators, Lenders and Wall Street Created America's Housing Crisis: Nine Proposals for a Long-Term Recovery" has received broad media coverage following its July 2007 submission to the Federal Reserve and FDIC.

Mr. Larson holds B.A. and B.S. degrees from Boston University.

Money and Markets (www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit www.moneyandmarkets.com.

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