Cut in Federal funds rate debated
WASHINGTON: Would cheaper money relieve the panic in financial markets about shoddy mortgages and declining home prices?
Even as the chairman of the Federal Reserve vowed Friday to act “as needed” to keep the economy from sliding into a recession, some analysts and even some policy makers caution that the central banks main tool may be ill-suited to the problem it faces.
Like horses that rear up at the sight of a rattlesnake, investors who financed commercial lending have become spooked as the housing bubble turned to a bust and foreclosure rates on subprime mortgages began to skyrocket.
Money for subprime mortgages, for people with weak credit, has already evaporated. And the paralysis has spread to more traditional home loans, business loans and corporate borrowing for billion-dollar leveraged buyouts.
But the Feds main weapon for restoring confidence - reducing its benchmark Federal funds rate on overnight loans between banks to 5 percent or less from 5.25 percent today - would have little effect on fears about credit quality.
“The reason there isnt a market for these credits is that people dont know what price they should be trading at,” said Edward Leamer, professor of management at University of California, Los Angeles, who presented a paper this weekend at the Federal Reserves symposium in Jackson Hole, Wyoming. “Thats not going to be affected by a small change in the federal funds rate.”
The meltdown in credit markets permeated discussions at Jackson Hole. In late-night chats over cognac, European central bankers and American hedge fund managers swapped stories about collapsing “conduits,” “special investment vehicles” and “SIV-lites” - entities that banks and private equity funds use to bundle and sell loans as securities.
The talk was not idle.
Over the next six weeks, more than $1 trillion worth of U.S. commercial debt is set to come due and will need to be refinanced, more than five times as much as came due since the panic began one month ago.
Fed officials say most of that $1 trillion in maturing debt has nothing to do with subprime loans or any other kind of mortgages. It includes credit card debt, car loans and business loans.
One official compared the load of maturing debt to a pig in a python: a bulge that would be take time to digest but could eventually be absorbed without huge problems.
Much of the digesting will be by big banks, which provided backup credit lines for their mortgage lenders.
But David Hale, a longtime Fed watcher, noted that at least two German banks needed to be rescued last month because of their exposure to American mortgages. Chances are very high that there will be more, Hale said.
Ben Bernanke, the Fed chairman, said Friday that the central bank was ready to act if the turmoil in credit markets threatened to undermine the overall economy.
On Wall Street, investors welcomed Bernankes remarks as a signal that the Fed will probably lower rates at its policy meeting Sept. 18. Many economists and hedge fund managers said the move would indeed shore up confidence.
More importantly, supporters of a lower Fed funds rate say it could prevent the huge looming losses from bad mortgages from expanding into even bigger losses on all kinds of loans.
“It would be a very powerful signal,” said Lewis Alexander, chief economist at Citigroup. “A critical determinant of housing prices is employment. If you think employment is going to weaken, your assumption for housing and for the ripple effects through the economy will be very different.”
