About That Fed Rate Cut
The Federal Reserve System interest rate cut to nearly 0% was a good move, right? On the plus side, it decreases the cost of borrowing for the federal government, and with nearly $20 trillion in debt, lower borrowing costs help every American taxpayer.
However, lower rates are a double-edged sword. The Fed can make borrowing more attractive by making it less expensive, but they can’t necessarily overcome borrowers’ fears of taking on more debt at such an uncertain time. As economists like to say, “You can’t push a string.”
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Another ill effect is that low rates put pressure on bank earnings, since the lower the rate the less a bank earns on a loan. The question is: How tuned in are investors to the likelihood of lower bank earnings in the future? Very.
Morgan Stanley (NYSE: MS), Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) are actually trading at less than their book value. What does that mean? Well, banks are valued at less than the cash that could be raised by liquidating them. When there’s a difference in the price of the same asset, traders call it an “arbitrage opportunity.” Though bank stocks look cheap when measured by their book value, they may get even cheaper after investors digest the next set of headlines.