The Fed's Recipe for Growth
STELZER, IRWIN M.
The Fed's Recipe for Growth Uncle Ben's wild rate cut. by Irwin M. Stelzer One and done. That's what | some commentators are saying about the decision of the Federal Reserve Board's mon- | etary...
...Corporate borrowers suddenly find capital markets open to them...
...And he might create that bane of all central bankers, moral hazard, j by bailing out improvident lenders and borrowers, emboldening them to repeat past errors, confident that the Fed will save their bacon every time...
...Oil and other commodity prices are rising, as are labor costs...
...If economic conditions deteriorate, last week's cut could be the first of several: Some forecasters think the Fed funds rate will fall to 4.0 percent by the first quarter of 2008, and to 3.5 percent by this time next year...
...Lessons have been, or should have been, learned: 1 Bernanke might have created some moral hazard by seeming to bail out financial institutions that behaved badly, but lenders are unlikely to throw money at the penurious homeless or firms dependent on that group...
...That's the verdict of the bond market, the institution that Clinton adviser James Carville held in such awe that he famously cried, "When I come back I want to come back as the bond market, because then you can intimidate everybody...
...The Fed chairman has demonstrated very important economic leadership," Jim O'Neill, Goldman Sachs's head of global economic research, told the firm's clients last week...
...1 Pragmatic activism trumps academic dithering...
...Applause for Ber-nanke reverberates in the halls of Congress, the boardrooms of America, and on the floors of the world's exchanges...
...Better to be a bit too generous, even with the attendant risks, if that's what it takes to forestall a possible cataclysm in financial markets...
...Both choices are not without risks...
...Most important to Bernanke's new legion of fans, stock prices have rebounded, and credit markets are beginning to function more normally...
...1 Most financial institutions in America are in good shape, with strong balance sheets...
...But too little, too late also carried risks...
...He admirably held to his anti-moral-hazard, hands-off policy...
...Lehman Brothers Holdings and General Electric immediately issued bonds, and R.H...
...When all is said and done, we are once again reminded of the wisdom of Walter Bagehot, who noted during the monetary crisis of 1857 that "panics will occur every now and then...
...Retail sales are not what shopkeepers would like (are they ever...
...Panic ensued, and the British government was forced to stem a bank run by guaranteeing bank deposits...
...Bernanke has no reason to fear boredom once the current crisis has passed...
...Talk now centers on when, not whether, King will be forced to resign...
...The turbulence originated in concerns about subprime mortgages, but the resulting global finan- j cial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans," Ber-nanke told Congress two days after Irwin M. Stelzer is a contributing editor to The Weekly Standard, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London...
...After "a quiet period in new transactions through the first quarter of 2008," Goldman Sachs's head of merchant banking, Rich Friedman, is advising his clients, deals will pick up, but they will be smaller and less wildly remunerative...
...No less an authority than Alan Greenspan, while careful to say that he "would be hard-pressed to see what I would have done differently," warns that because productivity is not likely to increase very rapidly, and the price-dampening effect of globalization has played itself out in part, inflationary pressures are on the rise...
...The inflation genie might still be bottled up, but the Fed chairman has fearlessly loosened the cap...
...Deal-makers emerged from their funk as the prospects for financing the backlog of transactions improved, although on terms less favorable than in the good old pre-credit-crunch days...
...Earnings remain relatively good, even at the troubled investment banks— Goldman Sachs stunned analysts by reporting robust revenues and profits for the last quarter...
...Long-term interest rates are up, as investors fear that the value of their investments will be eroded by inflation...
...some mortgage-related institutions are already in or on the brink of bankruptcy...
...Bankers have famously short memories, though, so some review of institutional regulation is probably in order...
...The Bush administration resisted efforts to expand significantly the ability of various agencies to ease conditions in mortgage markets, but has had to beat a partial retreat in the face of criticism from Democrats in Congress...
...Shortly after he cut rates, the government reported that consumer prices fell in August: so much for inflation fears...
...But the "one and done" crowd, which thinks Bernanke has headed off inflation by hinting he will not cut rates further, might be mistaken...
...Ben Ber-nanke's hero status contrasts sharply with that of Mervyn King, governor of the Bank of England...
...Donnelley sold more than $1 billion in junk bonds, the first such sale since the credit crunch hit in the summer...
...Financial markets are, to put it j mildly, nervous...
...So holds Bernanke...
...panicked depositors lined up last week in Britain to demand their money back from branches of Northern Rock...
...Not Bernanke, who remains calm in the face of rising long-term interest rates...
...and next year's resetting of teasingly low initial mortgage rates threatens tens of thousands of homeowners with foreclosure...
...The dollar's drop is accelerating so rapidly that it has fallen to par with the traditionally forlorn Canadian dollar for the first time since the 1970s...
...That's what | some commentators are saying about the decision of the Federal Reserve Board's mon- | etary policy committee to cut the Fed funds rate by 50 basis points (half of | a percentage point), twice what the j market had been expecting...
...They rea- j son that chairman Ben Bernanke had a choice between too much, too soon, and too little, too late—and chose the former...
...First, Bernanke may not be done...
...The markets are indeed worried...
...The contrast between Bernanke's popularity and King's likely fate will not be lost on central bankers...
...reducing the Fed funds rate from 5.25 to 4.75 percent...
...In America . . . we cannot reasonably anticipate anything but an occasional repetition...
...1 Ideology is a poor guide to policy during periods of financial difficulty...
...but back-to-school and luxury goods have moved smartly off the shelves...
...All of this has added to fears that Bernanke, who once joked that the way to end a recession is to drop money from helicopters, has won instant popularity at the price of future inflation...
...Cut rates and he might unleash inflation by stimulating an economy that is already growing at a reasonable pace...
...New data suggest that the jobs market is stronger than the earlier jobs reports led us to believe...
...No matter...
...Second, it is not clear that the economy is so soft that it can absorb this stimulus without an increase in inflation...
...Housing starts dropped to 42 percent below their January 2006 peak, a 12-year low, and the National Retail Federation is predicting a less than jolly Christmas selling season: so much for fears of an overheating economy...
...Credit is not easy to come by...
...Exports are rising at an annual rate of about 15 percent...
...The recent period of illiquidity had its impact, to be sure, but no major bank was threatened with destruction...
...So far, Bernanke's luck has held...
Vol. 13 • October 2007 • No. 3
