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Feds Ponzi Game Steps up a Notch
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12/16/2008 01:54 PM
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Fed Heads Into Uncharted Territory With Rate Cuts
As unemployment rises painfully higher and nest eggs are shattered, the Federal Reserve is prepared to slash a key interest rate—perhaps to an all-time low—in a desperate bid to stem the country's economic slide.
With the Fed's key rate dropping ever closer to zero, the central bank is moving into uncharted territory. Nonetheless, Fed Chairman Ben Bernanke has made it clear the Fed isn't running out of ammunition to fight the worst financial crisis since the 1930s.
It is exploring using tools—other than rate cuts—to revive the economy. New insights on that front could be revealed when Bernanke and his colleagues wrap up a two-day meeting Tuesday.
"The message is simply the Fed stands ready to do everything in its power to stop the economy's free fall," said Richard Yamarone, economist at Argus Research.
In its battle against a recession that started last December, the Fed already has cut the target for the federal funds rate, its main tool for influencing economic activity, to 1 percent, a level seen only once before in the last half-century.
Many economists predict the Fed will cut the funds rate in half—to just 0.50 percent.
A few think the Fed could opt for an even more forceful action—lowering rates by a whopping three-quarters percentage point or more. If that larger cut occurs, it would be the lowest on record that track the monthly average of the funds rate going back to 1954.
President-elect Barack Obama said Tuesday the Fed is "running out of the traditional ammunition" to fight the recession and that it was critical for other branches government to "step up." Obama, whose economic team is meeting Tuesday, is working on a "bold agenda" to spur an economic recovery.
The funds rate is the interest banks charge each other on overnight loans. The benefit of another Fed rate reduction, though, may be mostly psychological, rather than economic
"It's a feel-good thing," said economist Ken Mayland, president of ClearView Economics. "Hopefully this a bridge to better confidence."
Slammed by the financial crisis, worried banks have hoarded their cash and been extremely reluctant to lend money to customers.
Fearful consumers, watching jobs vanish and their investments tank, have sharply cut back their spending, including on big-ticket purchases like homes and cars that typically involve financing.
In response to the Fed's expected action, the prime rate—now at 4 percent—for many consumer and small-business loans would drop by a corresponding amount. The prime lending rate is used to peg rates on home equity loans, certain credit cards and other consumer loans.
Cheaper rates could give pinched borrowers a dose of relief. The goal of lower borrowing costs is to entice people and businesses to spend more, which would revive the economy.
So far, though, the Fed's aggressive rate reductions have failed to stabilize the economy.
Bernanke says the Fed is weighing other ways to aid the economy given that it can lower the funds rate only so far—to zero. For example, the Fed could buy longer-term Treasury or agency securities on the open market in substantial quantities.
By boosting the quantity of money in the financial system, the Fed has engaged in so-called "quantitative easing" to provide economic relief. The Fed's balance sheet has ballooned to $2.2 trillion, from close to $900 billion in September, reflecting efforts to mend the financial system.
"Never in the postwar history has the Fed acted as lender of last resort to this degree," Mayland said.
In fact, with all the lending by the Fed, the actual funds rate has fallen at times well below its current 1 percent target.
Hours before the Fed's announcement, the Labor Department reported that consumer prices fell by a record 1.7 percent in November as energy prices retreated. It marked the second straight month that prices dropped and raised the specter that the country could be heading for a dangerous bout of deflation.
Deflation means a widespread—and prolonged—decline in prices that hits Americans' incomes and corporate profits as well as already stricken housing values and investments. Lower rates by the Fed would help fend it off.
Another report underlined the housing market's woes. The number of housing projects started in November plunged by the most in a quarter-century as builders slashed production, the Commerce Department reported.
As housing, credit and financial problems persist, the economic rubble mounts higher. Shell-shocked employers axed 533,000 jobs in November alone.That drove the unemployment rate up to 6.7 percent, a 15-year high.
Since the start of the recession, the economy has shed nearly 2 million jobs. Analysts predict another 3 million more will be lost between now and the spring of 2010.
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