Rates fell about 25 basis points over the last month for fixed-rate residential mortgages, with a similar drop in the benchmark T-Bill rates for both business operating and capital loans, including commercial mortgages. However rates did not decline for adjustable rate mortgages as lender remain concerned about credit quality with applicants for these mortgages. Furthermore, the progressive tightening of credit approval standards, even for prime borrowers, kept the full impact of cheaper credit from jumbo residential and commercial mortgage applicants.

The early December 0.25 percentage point cut in the federal funds rate was already priced into market interest rates so it will not push construction financing costs down further. However, another quarter-point percentage cut widely anticipated for six weeks later will lead to a further small decline in mortgage rates.

Target is to Assure Liquidity rather than Drive Spending
The resumed monetary easing is not targeting interest rates to stimulate borrowing and spending to boost the economy. Rather, its goal is to pump liquidity into the financial system to assure that lenders can meet the normal business loan needs of all borrowers without imposing delays or a rise in rates to ration scarce credit.

The supply of available funds is also being strained by now-declining profits for domestic corporations and the need of foreign banks to cover the losses from re-pricing risky assets in other countries. If the Federal Reserve Board fails to accomplish this, a recession would be almost certain within a few months.

Cheaper mortgage rates are an inevitable consequence of assuring enough liquidity. How much liquidity has to be pumped into the financial system is still uncertain. It is clearly more than thought initially last August, as reports from investors all over the world continue to mount of capital diverted from lendable funds to loan loss reserves for residential mortgages.

In 2009, Earlier Rate Cuts Will Boost Economy
At some point the world banking system will have enough liquidity, cash injections from central banks will stop and the focus will shift to moping up excess credit to prevent inflation. This will be a repeat of what happened from late 2004 until a few months ago. Note that this is the period when construction spending rose quickly because the negative impact of higher credit costs was more than offset by the positive impact of an improving economy.

In the current financial cycle, 2008 is the year when rates are cut and remain low, but the economy is still sluggish. The year 2009 is when the earlier monetary stimulus will boost the economy enough to overcome the impact of Central banks moping up excess liquidity.

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