FCF Blog

Victor Weintraub is the President of First Charter Financial Corporation. A noted economist he writes this blog to keep our clients informed on economic issues that can have an impact on commercial Real Estate investment and most importantly on interest rates and the capital markets.

Mr. Weintraub holds a Bachelor's Degree in engineering from New York University. He received his MBA from Columbia University, Graduate School of Business. He has been in the commercial financing business for more than fourty years.

In addition to his economic writing Mr. Weintraub has written several books and novels. including the Robert Hazard spy thriller series. He is also President of First Capitol books a publisher of E books and print books distributed throughout the English-speaking world.


September 15, 2017

Everyone pretty much agrees that interest rates are headed higher. By everyone I include the experts who appear on CNBC and Bloomberg. The commentators from all of the other news shows and the financial newspapers. They have all reached this conclusion but none tells you why and what the result of higher interest rates will be.

The Federal Reserve, the US central bank, has worked itself into a corner and has left itself very little room to maneuver. To make things more complicated they have been followed by other central banks, The Bank of Japan and the European Central Bank. This is the result of the near economic collapse that occurred in 2008 and 2009. The Fed did a massive easing of money. They dropped interest rate to historic lows. They increase liquidity by an enormous amount. In spite of the lack of physical stimulus because of politics the Fed saved the economy. We did not have a deep depression, instead we have had a milder recession and a slow recovery.

As the US central-bank, the Fed has the ability to print money and that is exactly what they did. If you look in your wallet you will see that your money is not issued by the US Treasury, your money is Federal Reserve Notes that are issued by the FED. The way it works is the Treasury sells bonds. If the Fed buys the bonds they give the Treasury Dollars as Federal Reserve Notes. The Treasury pays its bills and the amount of Federal Reserve Notes, money in the economy increases. If the public buys the Treasury Bonds the amount of money in the economy is unchanged. When the Fed is an active buyer of bonds it drives the price of bonds up and therefore interest rates go down. When they are a seller of bonds that drives the price of bonds down and interest rates go up. This buying and selling of bonds is called the Fed open market operations. It has been more important in setting interest rates than the Federal Funds rate that everyone follows after every Fed meeting.

In 2008 the Federal Reserve had less than $1 trillion of bonds on its balance sheet. Today the Fed has $4.5 trillion of bonds on the balance sheet. With the economy expected to improve now the Fed has announced that it will begin to reduce its holdings of bonds. This will be done by allowing existing bonds to run off at maturity and not be replaced by purchases in the open market. Europe and Japan have also been purchasing bonds. The Japanese intend to keep their balance up while Europe has decided to slow their purchase and they are looking toward decreasing their balance in the near future. What this all amounts to is that we can expect the Fed to reduce its position by as much as $50 billion per month, $600 billion per year. The replacement bonds will have to be purchased by private buyers That will cause liquidity in the economy to decline. Therefor interest rates will go up to attract buyers as they went down when the FED was an active buyer.

When a central bank dramatically increases liquidity, the expectation is that it will result in inflation and a decline in the value of the currency. This did not happen when the FED added over $3.5 trillion to the economy. In 2008 the economy was so weak that the continuing injection of liquidity did not rapidly produce sufficient demand to spill over as wage and price inflation. Unemployment was very high and industrial production was very weak. Consumers were coping with a collapsing residential real estate market and consumer debt burden. The new liquidity coming into the economy did stop a recession from turning into a 1930s style depression. Slowly the economy started to recover.

So where did the liquidity pumped into the economy by the Fed go? First into the banking system. Liquidity repaired the balance sheets and liquidity of the banks. Second into the Stock Market. After a major decline it made a bottom in March of 2009. Commercial real estate also benefited.

It is a basic economic rule. When interest rates go down, stock market price to earnings ratios go up and the stock market will go up. As interest rates go down capitalization rates for investment real estate go down and values go up. The same happens with other investments. It is a quest for yield that propels values. Our economic problems of 2008 spilled over to the rest of the world and that prevented the Dollar from a decline against other currencies.

It has taken us nine years to finally to get an economic recovery, although it is still not very strong. We will see how things go. More on this in my next FCF BLOG.

Victor Weintraub

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