There are many opinions on how best to captain a gigantic national economy across roiled seas. No one can presume to know the best course with real certainty. All must contend with an unknowable future string of consequences from action and inaction. Past history is hard to know with clarity and context is ever changing. Every Federal Reserve Chairman is owed some deference as he/she charts a course to please diverse constituencies, dodge rocks and sail through storms. Now that we got that out of the way, what is Slash and Buckle Ben thinking? We have heard much of Ben's discipline and prudent approach. We have been treated to talk of his careful and technically advanced reliance on cold calculation. Oops, that seems to have lasted about one month of market turmoil.
What happened?
On September 18, 2007 the Federal Reserve's Open Market Committee cut its target rate for interbank loans -- the Federal Funds Rate- - by 50 basis points or .5%. During the same meeting a 50 basis point cut was made in the Discount Rate -- the rate at which the Fed lends to banks. This leaves the Fed Funds target rate at 4.75% and the discount rate 5.25%. The Fed felt the pressing need to cut its target Fed Funds rate by 9.5% and it's Discount Rate by 8.7%. Markets, speculators and Congress had been calling for such dramatic responses to buoy markets and financial conditions. Oh yeah, they also blabbered something about helping families like the 260,000 that saw their homes enter foreclosure in August. It is too late for them but, they make better poster children than the likely beneficiaries.
How can we situate this historically?
By way of benchmarking these rates, some historical perspective is in order. In the 50-year period from 1957-2006 the average effective Federal Funds Rate was 5.88%. We were below the long run average before the cut and are now well below the long run average. The average for the last 20 years was 4.9%. We are now below that average as well. Over the period from 1957-2002 the average Discount Rate was 5.59%. We have moved below this average as well. The 20-year Discount Rate average was 5.64%. Thus, it would be fair to say we were below the averages prior to these cuts and are now further below the averages. How might you understand that? We are a debt economy and require move accommodative and easy money then ever before. Turmoil in credit markets is very dangerous and we can no longer have a stable economy with historically "normal" interest rates. Give us cheap, easy money or the economy walks the plank!
What makes this unnerving?
A million years ago, on August 07, 2007, the Fed saw inflation risks and a generally strong economy. I must admit, I found that shocking and wondered what they were smoking. They must have too, because a whopping ten days later they acted in complete contradiction to that position. On August 17, 2007, the Fed slammed those betting on markets to fall by suddenly slashing the cost, condition and collateral for bank borrowing. They cut the Discount Rate and began accepting more types of collateral for longer periods. Banks did take advantage of this. They hit the Fed credit buffet like Las Vegas tourists. These well fed bankers are yet to extend any much extra opportunity to legions of distressed debtors. Foreclosures continued to break records and went on to a 115% increase over August 2006. Not to worry, monetary policy is really made for middle and lower income Americans. The bankers may be at the buffet, but the great unwashed get to play in the bankruptcy casino downstairs. Who wants a free meal when there are opportunities to play foreclosure roulette?
The August 07, FOMC statement sounds of confidence and offers an all-clear:
Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy. --FOMC Statement 08/07/07
In Fed-speak this is tantamount to an "all is well, remain calm." Thus, Tuesday's actions and pronouncement are both strange and contradictory.
Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.
Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. -- FOMC Statement 9/18/07
Toward a gentle and respectful critique
There is so much to say here. The first half of the year ended before either meeting! Growth in the second quarter has been revised upward since the August meeting, so it is better than we thought on August 07. It appears that the Fed is acting to prevent a downward economic trend that could arise. That sounds great until you realize that this has already come to pass! Who are they kidding? Not the quarter million America households that formally entered the losing their house good times in August. Backward looking data that measures August made inflation look moderate. That data concerns August but, was released lately. Preliminary access to that data was available during the August meeting and throughout last month. New data for September is available now -- after all it is September now! This data suggests rising prices led by surging oil, wheat, gold and foreign currency prices. Not to worry, the Fed will monitor that while pumping money into banks and slashing rates to prevent the economic downturn that has already arrived!
In early August it was clear that foreclosures were spiking, markets were boiling over and panic was rife. Ben Buckle decided that it was time to sound the all clear with a cautionary note on inflation risks. After all, oil was a whopping and scary $70 a barrel back then. Now it was settled down to $82 and so the worry has lifted? Food costs -- especially wheat -- have surged in the month since the Fed worried about inflation. I guess that is why we are now worried about financial market conditions. Across the month and week between the meetings the broadest US stock market index, S&P500, went from 1476.71 to Monday's close of 1476.65. This must have been the radical deterioration that caused the about face!
Slash and Buckle Ben is ideally focused on inflation fighting, price stability and economic growth. It would seem he is concerned about bank demands for liquidity and equity market indexes. I am not saying there is anything wrong with that. I am saying the talk, the action and the statements are not anywhere near to being on the same page. Action and pronouncement swing between mutually exclusive broad outlooks. Fast and furious actions are targeting asset prices and ignoring reported economic data, except when obsessed with increasingly outdated numbers? There must be a real draw down in the rum supply aboard the Pirate Ship Bernanke?
Tuesday's reassurance and logic are as frightening as the logic and all clear sounded on August 07, 2007. Bucking to Wall Street pressure and slashing rates helps stocks prices. The way and timing in which the Discount Rate was cut -- twice now -- attacks market shorts and artificially pushes up stock prices. Thus, it will be seen as genius by those you hear from on TV, radio, many newspapers. I am concerned that the Fed acted late, is confused about where we are in the calendar year, pays no mind to its recent statements and is acting to head off future economic trouble that everyone else knows is already here.