Fallout: The Financial Crisis

Analysts react to Fed rate cut

John Dimsdale Oct 31, 2008
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Fallout: The Financial Crisis

Analysts react to Fed rate cut

John Dimsdale Oct 31, 2008
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TEXT OF STORY

Tess Vigeland: So the economy contracted a wicked three-tenths of a percent in the third quarter. It’s the first decline in gross domestic product since 2001.

Instead of donning a fright wig and running screaming like a banshee into a blackened forest Fed chairman Ben Bernanke presided over yet another interest rate cut, this time to within striking distance of zero. The central bank is trying to make it cheaper for businesses and individuals to borrow money.

John Dimsdale looks at whether it’s just another trick or a sweet treat to unwind the goblins in the credit markets.


John Dimsdale: When the credit crisis began in the summer of 2007, the overnight lending rate was 5.25 percent and ever since the Fed has aggressively pushed interest rates lower to kickstart the faltering economy.

Ira Kaminow, a former member of the Philadelphia Federal Reserve, says it’ll take a while for the central bank’s rate cuts to filter down to the consumer level. For example, credit card interest charges still reflect tight credit conditions. However, immediately after Wednesday’s Fed action, several commercial banks lowered the prime rate they charge their best customers which Kaminow says should benefit homebuyers, especially those with adjustable rate mortgages.

Ira Kaminow: It’s going to help all those interest rates that are tied, for example, to the bank prime rate and that’s going to help encourage people to borrow a little more perhaps.

But Kaminow and other economists worry the Fed has become overzealous in its rate-cutting fervor. Villanova Business School professor Victor Li says extremely low rates could encourage more of the same bad loans that got us in this crisis in the first place.

Victor Li: If you keep rates too low for too long, it may encourage the additional risk-taking that occurred for example when Alan Greenspan was chairman of the Fed. One of the things people point to is he kept those rates too low for too long and that may have contributed to the current situation.

Even with short-term rates at a record low, Fed board members say they’re still worried about the economy and signal they might cut again in December.

But Gerald O’Driscoll, a former vice chairman of the Dallas Fed, says today’s central bankers have just about run out of ammunition.

Gerald O’Driscoll: There’s not much further they can go. They can go to zero and the Japanese did that in the 90s at one point, but this is an election year and they have to be seen to be doing everything they can do so I think they’re being aggressive.

O’Driscoll says loosening the interest rate screws is the Fed’s best tool for avoiding recession. But others like Peter Schiff, the president of Euro Pacific Capital, say the Fed is turning the screws in the wrong direction.

Peter Schiff: What the U.S. economy needs is the opposite. We need for Americans to stop borrowing. We need Americans to start saving their money and lower interest rates is going to punish people who are saving money and encourage more of the reckless borrowing and spending that is the reason we’re in this mess.

Schiff says the Fed’s easy money policies are repeating Japan’s mistakes when that country propped up banks that were poorly managed and should have been allowed to fail. The result, he says, has been nearly two decades of anemic economic growth.

In Washington, I’m John Dimsdale for Marketplace Money.

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