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August 27, 1994
In a week of quiet trading and little news, mortgage rates came back down to the same place they were before last week's Fed tightening.
July Durable Goods Orders fell 4.2%, their third drop in a row, and Existing Home Sales declined .3%.
Nine-year old kids often gather to challenge each others' knowledge of the longest word in the world.
In economics, length is not as important as making sure that things stay complicated. However, every once in a while, a word comes along which meets both objectives.
"Disintermediation." Nyah, nyah, nyah-nyah, nyah.
The word describes the economic situation which triggered most of the recessions since World War II, and the condition which has not yet appeared in 1994 despite a nice try by the Fed.
The word is a good one, in that if you take its pieces apart, you can remember what the hell it means. The "dis" part means that we have negative "intermediation." In the financial sense, an "intermediary" is a bank.
Successful intermediation is a great many depositors giving their money to banks, which turn all the liquid cash into awkward, specialized, and illiquid loans. Without banks, it would be very hard for depositors to band together to finance IBM, or for that matter, the local grocery chain.
When the Fed tries to cool off the economy, it raises rates. However, high rates by themselves can take a long time and great height to do the job. High rates discourage borrowing, but at the same time they generate a lot of increased income for people with savings.
The Fed needs some way to magnify a mere rise in rates: it needs to get the intemediaries out of the loan business.
The general idea is to drive up the yields on Treasurys until they are higher than the rates which banks pay. Then depositors will move their money out of banks and into Treasurys. Less intermediation, few loans, cool economy.
In the last six months, the Fed has raised its key interest rate, the Fed funds rate, a total of 1.75%. Banks should be forced to pay higher rates to their depositors, and have to pass the cost through to their loan customers, and their loan customers should be refusing to pay those high rates. This last ratchet by the Fed, and money should be flooding into Treasurys, disintermediation underway.
Er, no. A brand new report shows yields on bank money market accounts have gone down .25% since the Fed got started in February. Rates paid on CDs have risen hardly at all. Depositors are undercompensated, but staying put, and nobody knows why.
The intermediaries are still intermediating their little, hard, cold hearts out, which isn't good news if you are hoping a slow economy will hold down mortgage rates.
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