In Focus

KISS-ing with the Fed

Since recent interest rate hikes have been blamed for much of the market's current volatility, I thought a little discussion on interest rates and the Federal Reserve was in order. Hack, hack, choke, cough. who wants to talk about that, you say? Well, Chickies, we do!!! Don't worry. With our credo, "Keep It Simple Sistah," there's nothing we can't tackle and understand! Hmmm, where should I begin? How 'bout with the Federal Reserve? Or as they are more fondly referred, "The Fed." You hear about them all the time. Eight times per year CNBC is on "Fed Watch".

Try and follow along here - this is sort of the framework for the whole process. The Federal Reserve System was established in 1913. It is made up of 12 Federal Reserve Banks across the country. These banks are all accountable to 7 people appointed by the president, calling themselves the Federal Reserve Board. The Fed Chairman is included among them. There is one last group that you should become familiar with: the FOMC or Federal Open Market Committee. The entire market, it seems, balances on the decisions made by this committee. It has 12 members, including the 7 appointees of the board. The additional 5 spaces are filled by the presidents of the regional Federal Reserve Banks. Since there are 12 of these banks and only 5 spaces, the presidents serve on the committee on a rotating basis.

There! Now the next time you hear news of the "Fed," you'll be able to clarify whether they're talking about the Federal Reserve System, the Board or the FOMC. Most often, it's the latter. Way to go, Chickie!

Can you guess who is the BMOC of the FOMC? (That would be the "big man on campus" or the "grand pubah," otherwise known as the Chairman of the Fed.) You may not know or understand what he does, but I bet you've at least heard his name. If you guessed Alan Greenspan, you got it! Just what do he and his little gang do? In a sentence, they set monetary policy. I know, I know, what does that mean to a Chick? Well, what they really affect are interest rates. And how does that in turn affect me. you. us? Let's see, there's the interest rate I earn in my checking and savings accounts. We quibbled over the interest rates for our home and car loans, and then there's that dreaded interest rate that I try to stay clear of.credit card debt!! The decisions of the FOMC affect all of these in one way or another.

All right, tweak your beaks just a bit because I'm going to tell you how it works when the committee decides to take action. Remember, I only know how to KISS and tell, so it shouldn't be too hard to understand. There are actually two rates that the FOMC can adjust: the federal discount rate and the federal funds rate. Despite their differences, changes in either fulfill basically the same purpose. It is the federal funds rate which attracts the most attention, so it's the one we'll focus on. This is the interest rate that banks charge each other. Banks are required to keep a certain amount of money in the Federal Reserve. Those that have an amount that is in excess of the minimum are allowed to loan money to other banks that are running short. Banks cannot collect interest for their money held in the Reserve. However, they are allowed to collect interest on their loans to other banks. Pretty cool, huh? No wonder they do it. Again, the rate of interest banks charge other banks is known as the federal funds rate.

So what are the ramifications of a rate change? It is estimated that there is a 12-18 month lag time between a rate change and its impact on the economy. In general, increases in either rate are intended to slow the economy, thus preventing inflation. Decreases are used to spur economic growth or jumpstart the economy. The rule of thumb for the stock market is that higher interest rates are bad for the market, while lower interest rates are bullish. Imagine how expensive it becomes to do business for a huge corporation with a heavy debt load if interest rates go up! Companies are forced to raise their prices, followed by consumers reducing their spending, which in turn leaves companies with lower earnings and finally, falling stock prices. On a more personal level, since the banks are having to pay more, they, in turn pass on their costs to the consumer. It becomes much more expensive to have any kind of debt.that includes car and mortgage loans as well as the interest rate charged by credit card companies. The only positive affect in a Chick's pocketbook is that the interest earned in any interest-bearing money account goes up as well. The fed is simply trying to slow our growth to a sustainable rate.

We long term investors should be happy that the Fed stays on top of things. Even though the market often seems as volatile as a two year old, like dear old grandma, the Fed is always there to offer its soothing touch. Okay, maybe that analogy is a bit on the optimistic side, but you get my point. Like medicine, it may not taste so good going down, but often it does just the trick! Now a Chickie Challenge: the next time the FOMC meets, see how much of what comes out of it you understand. Remember, their "press releases" are filled with mumbo-jumbo that seem designed to confuse, but see if you can't discern what action they are taking (no action or moving rates up or down), which rate they are adjusting and why.

Go get 'em Chicks!!!