My Two Cents

A Quarter Point Cut?

Chris Farrell Sep 14, 2007

Economists are almost unanimous in their agreement that the credit crunch will translate into slower economic growth. The differences are in degree. Economists like Martin Feldstein of Harvard University put high odds on a recession since in the post World War 11 era downturns in the housing market have usually ended in recession. The financial and psychological impact of changes in home prices is bigger than other assets. On the upside, rising home prices spur all kinds of consumer spending and a willingness to borrow; but on the downside the negative impact is equally substantial.

The more optimistic camp, such as Wall Street economist Ed Yardeni, believe there is still ample credit and liquidity in the global capital markets. Once the credit turmoil stablizes growth will resume.

I think the credit squeeze is subsiding, although the calm will be punctuated by periodic eruptions of trouble. And there is a lot of hedge fund/risk money being gathered to buy bad debts on the cheap from banks, investment banks, and other lenders eager to shed their non-performing loans.

The fed is most likely to cut its benchmark interest rate by a quarter point tomorrow. Here’s why: 1) The downturn in the housing market; 2) signs of trouble in the labor market with payroll employment averaging only 44,300 a month over the past three months; 3) China’s central bank continuing to tighten policy in an attempt to cool off speculative fever in the Asian giant. The latter is critical because China’s rapid growth has helped contain the economic impact of the global credit squeeze. But at some point, central banks always succeed in slowing down an economy. The real question is by how much and how fast. The oft-hoped for soft-landings is the exception, not the rule; and 4) a half-point move would signal that the problems in nthe credit market run much, much deeper than even pessimists now believe. The move carries the risk of backfiring badly on the Fed. .

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