Financial federal funds rate is the level of interest

Financial Report Paper

Many
different things effect and make up the economy.  Things like housing, stocks and bonds,
mortgages, and many more all come together to give us our economy.  Each different market has an effect on the
others.  The housing market has had a
large impact on the economy over the past few decades, with the housing boom
and the bust that followed. That boom and bust took the entire economy on a
crazy ride.

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Impact
of Housing Market on Bond Market, Stock Market, Mortgage Market, and Economy

In
December of 2016, The Federal Reserve raised its benchmark interest rate. This
has an effect on the cost of housing, cars, student loans, and credit card
interest. This move is part of slowly increasing the federal funds rate.  The federal funds rate is the level of interest
that applies to short-term loans between financial institutions to help them
maintain their reserve requirements. These rates have been near zero since the
2008 recession.  With the recent
improvement in the economy, this rate will finally begin to increase
(Russonello, 2016). In 2017, the rate was raised twice, and is between 1 and
1.25 percent.  It did not change in
November, but is expected to increase in December (Swanson, 2017).

In
anticipation of future rate increases, long-term mortgage rates have been
increasing.  Since most mortgages are
written as a 30-year, fixed rate mortgage, finance institutions are finding
ways to pass their own higher costs on to borrowers.  While adding a percentage point to the
interest rate does not seem like it would cause a large impact, it actually
does.  The average mortgage loan is for
$237,000.  Increasing interest by one
percent would mean adding approximately $138 a month to the mortgage, which
means an additional $50,000 paid in interest over the 30 years of the loan.
Increasing interest rates mean people are less likely to buy a house or
refinance their current home (Russonello, 2016). 

This
not only affects the housing market, but also the job market.  As mortgage interest rates increase, fewer
people choose to buy homes.  This locks
current homeowners into their location. With fewer people buying houses,
housing prices decrease.  Homeowners
wanting to sell are at a disadvantage.  This
limits their ability to find work elsewhere. 
Researchers studied the effect of the housing crash on job
searches.  By analyzing applications to
online job postings between May 2008 and December 2009, they found a
correlation between home values and job applications.  A thirty percent decline in home values led
to a fifteen percent decline in applications for jobs outside of the job
seeker’s commuting zone.  When job
searchers are constrained to a certain commuting zone, they are more likely to
apply for lower-level and lower-paying positions. This had positive and
negative effects on firms.  Firms had
less access to a national labor market. 
At the same time, firms faced less competition for labor and were able
to hire qualified workers at lower salaries (Fitzgerald, 2017).

On
the first Friday of every month, the US Labor Department reports the key
employment data for the previous month.  The
information includes the unemployment rate, the absolute number of jobs added
or lost, total hours worked, average hourly wages, and how the jobs picture for
various sectors has fared. Of all the economic reports, the jobs report has the
largest impact on the bond market (Kenny, 2017).

The
job market is considered the heartbeat of the economy.  It is an indicator of the health of the economy
as well as an engine of growth. A positive job report has a negative impact on
bond prices.  Job growth could lead to an
increase in interest rates by the Federal Reserve.  The prospect of raising rates causes yields
to rise and prices to fall for Treasuries and other segments of the market,
such as municipal bonds, mortgage-backed securities, and corporate bonds.
Growth can also increase the chance of inflation.  Higher inflation affects bond prices. A
weaker jobs report tends to be positive for the bond market for the opposite
reason (Kenny, 2017).

The
housing market affects the economy not just through mortgages rates.  In 2016, construction of real estate
contributed $1.2 trillion to the gross domestic product.  That is six percent of the US GDP.  This is higher than its peak in 2006 of
$1.195 trillion. Construction is very labor intensive, so a change in new
housing construction has a large impact on the unemployment rate. Another
factor in housing market is home equity loans. 
A reduction in home equity loans reduces consumer spending.  Since almost seventy percent of the US
economy is based on personal consumption, a reduction in consumer spending
reduces the economy (Amadeo, 2017).

Studies
of the stock market and housing markets show a significant correlation between
the two.  A study conducted by Erik
Andersson that looked at the two markets between 1987 and 2013 indicated a
unidirectional causality running from the stock market to the housing
market.  It showed that changes in the
stock market had an immediate effect on housing and reached its full effect
after just three quarters. A one percentage point change in the stock market
translates to a 0.0326 percent change in housing after one year, 0.1423 percent
after three years, and 0.2175 percent after 5 years. While these percentages
seem small, it translates into much larger changes in the value of real estate
owned by American households; a reduction of $7.04 billion after one year,
$30.75 billion after three years, and $47.00 billion after five years
(Anderson, 2014).

The
Fed’s Actions

The
consensus seems to be that the steady increase in the housing market will lead
to the Fed increasing interest rates. 
The theory behind increasing interest rates is that it will cause the
growth in the economy, including the housing market, to slow down.  Increasing too much too fast can lead to
inflation.  The Fed wants to avoid
inflation without completely stagnating the economy.  This is done by making adjustments to the
interest rate.  A higher interest rate
will slow down borrowing, due to higher interest costs.  This will slow down spending. The economy
slows, and inflation is avoided.  The Fed
must be careful not to raise interest rates too much, or it will have too
adverse of an effect on the economy.  It
is a balancing act.

I
agree that the Fed will be, and should, increase interest rates.  In particular, this should happen to slow
down the growth in the housing market. 
In most parts of the country, housing prices continue to rise, and are
nearing the levels of just before the housing bubble burst.  The market burst and subsequent financial
crisis cannot be allowed to happen again. 
Even though it may result in some job loss, the Fed must raise interest
rates in order to slow the housing market growth. 

Impact
on Commercial Banks, Insurance Companies, and Mutual Funds

Raising
interest rates will not only impact the housing market, but also commercial
banks, insurance companies, and mutual funds. 
Unlike other areas of the economy, these thrive when the rates increase.  A rate increase typically happens in a strong
economy.  This means that borrowers are
better able to make loan payments and banks have fewer non-performing assets
and defaulted loans.  Mutual funds show
and increase, as a healthy, strong economy means more investment activity.  Insurance companies flourish as rates
rise.  Not only are they earning more on
the investments of premiums, but a strong economy means insureds are purchasing
new cars, homes, and other big ticket items that require insurance coverage.  In addition, the increase in the housing
market leads to an increase in home owners’ insurance premiums (Bloomenthal,
n.d.).

In
anticipation of the increased rates, commercial banks, insurance companies, and
mutual funds should prepare.  Commercial
banks will need to offset the net loss due to long-term fixed rate loans by
increasing the rates on new loans.  They
should take advantage of the increase in profitability of companies by offering
attractive loans for expansion.  They
should also take advantage of the increase in purchasing of luxury items.  These advantages should be taken before the
rate increase causes a slowing of the economy. 
They should not, however, lower the loan requirements in order to bring
in customers that are less desirable just to produce more loans.  Discretion should still be used in lending.
Insurance companies should take advantage of the current situation by making
wise short term investments that can be cashed in before the interest rate
increases go into effect.  Mutual funds
should continue to diversify.  While the
housing market is still strong, it is a good investment, but the increase in
interest rates will cause it to slow down. 
Fund managers need to be aware of the changes that will take place and
move investments into other areas, such as insurance or banks.

Conclusion

The
different financial markets are all connected. 
Changes in one causes changes in the others.  And those changes cause other changes to
occur.  It is a balancing act in keeping
the economy stable but at a level that is beneficial for the country as a
whole.  That is not always possible, but
it should be strived for, and that is what the Fed attempts to do when making
changes to the interest rates.  While
those invested in housing have a financial desire to see it continue to grow,
we cannot allow it to happen unchecked. 
We do not need another burst and ensuing financial crisis.  We need to learn from the past and protect
the financial future of our economy.