As a Tampa Mortgage broker, I get this question all the time. Here’s my take on the issue.
The Federal Reserve is, in effect, the Banking Arm of the United States Government. It provides banking services to US banks and to the government itself. One other very important role the Fed plays is as the financial policy development head for our country. It’s this function that sets into motion and situates the financial interest rates that impact everything from stocks, to bonds, to credit cards, and yes – to your Tampa mortgage.
The Fed Influences the Money Supply in 3 Ways
Although some believe that Uncle Ben (Bernanke) and company – (THE FED) have the ability to set interest rates willy nilly – as if playing “man behind the curtain within a financial Oz, this is not the case. In truth, the Fed has little to no control over the various factors that shape the supply of funds in this country. However, there are 3 key ways that the Fed does hold sway over US money supplies:
- First, the Federal Reserve loans money directly to banks, albeit on a limited scale.
- Second, the Fed sometimes makes changes to its regulations regarding how much money it requires banks to keep on reserve.
- Third… and this is the most important way the Fed influences the supply of money in the United States… it uses what it calls “open market operations” to move money into and out of the banking system.
So, How Does the Fed’s Open Market Operation Really Work?
Picture this: you are now the head honcho – big cheese – grand poobah (Gotta respect Fred and Barney) of ACME Regional Bank. As the boss, your job is to make your bank as much money as you can. Good so far? Cool. OK – so, one of the key ways you earn money for your bank is to make loans, for which you charge specific interest amounts. This interest comes back to your ACME Regional Bank and your cash holdings grow accordingly.
Now – the Fed mandates that you keep a set amount of cash reserves in your bank at a all times. As the boss at your bank, it’s your job to maintain these required reserves.
Here’s the fun part. The bulk of the money you use to make loans comes from the cash deposits made by your bank’s customers. Because you never really know how much money customers will deposit or withdraw each day, planning to keep a set amount of cash in reserves at all times can be a bit tricky. Run short even for a little while, and you are going to have to find a way to cover the difference. Good thing you’re smart – and you know just where to go to get that extra cash when you need it to cover your reserve amount! Guess where you’ll go… yup! Your neighboring banks! GOLD STAR FOR YOU!
See, other bank managers may have extra money on hand, and they’re more than happy to earn interest off of it loaning it to you just as they would one of their bank customers. The only haggling point will be… can you guess? Right again! The amount of interest you will pay for the privilege of borrowing money from your neighboring bank.
But how much interest will this other bank charge your bank ? Well, this will vary – based on the flow of money at the time. See, if a good number of banks have cash on hand to loan out – then they’re all going to be hungry to make whatever interest on that cash they can. Consequently, you’ll have supply and demand working in your site and chances are – your interest rate will be pretty low. However, if money is tight among banks, and they all know you’re hurting to borrow some – guess what. Whammo! You get to pay a higher interest rate!
So – The Fed Buys and Sells Securities to Influence Interest Rates in the Same Manner…
By buying and selling securities on the open market, the Federal Reserve can, in effect, influence interest rates. If Uncle Ben and crew want rates to go up, they simply sell off a ton of securities. The buyers of those securities pay the Fed millions, even billions, of dollars. This money comes right out of the buyers’ bank accounts, reducing the amount of reserves in the banking system. At this point, if you’re in your “bank boss” mode – you’re sweating it – because money in your bank’s reserves is getting tight. As such, the rate you charge when you loan out what money you do have in “overnight loans” to other banks will go up. This rate – by the way – is called the “Federal Funds Rate” for a reason.
The same supply-and-demand rules apply when the situation is reversed. When the Fed buys securities, it pays millions, even billions, of dollars into the sellers’ bank accounts, increasing the amount of reserves in the banking system. With more money out there to loan, the federal funds rate goes down.
Nota Bene: These changes don’t impact “mortgage rates” immediately. However, over time, changes in the federal funds rate will lead to changes in short-term interest rates, then work their way into changing long-term interest rates (read here as “Tampa mortgage” rates).
Put simply – when the Fed pushes rates downward, it’s hoping to spur economic stimulation. When it moves to create upward pressure on the Fed funds rate – it’s hoping to fight inflation.
I hope you found this post useful! As always, if you or anyone you know is in need of a local Florida mortgage broker, I’m your guy. Call me at 863-604-3019 or apply online for your Florida mortgage. We’ll keep you posted and let you know when it’s time to pull the trigger!
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