Rate cut can cure our hangover from credit binge

By CHRIS LESTER
The Kansas City Star

The Federal Reserve’s key policymaking committee gathers today with more eyes trained on it than in years.

The financial markets already have priced in at least a quarter-point cut in the federal funds target rate, which would reduce it to 5 percent. But some folks are already calling for a larger cut, to 4.75 percent, in hopes of heading off a recession caused by problems in the housing and credit markets.

A cut certainly would be notable news.

The Fed hasn’t cut its target short-term rate since June 2003, when it was reduced to a paltry 1 percent — effectively setting off a credit binge.

At the time, the Alan Greenspan-led Fed said the cuts were aimed at heading off fears of deflation and supporting the economy as it recovered from the last recession.

Lenders and borrowers enthusiastically tapped into the virtually free money to make a whole lot of what, in retrospect, have become shaky loans, particularly in the subprime mortgage industry.

The cheap money certainly bolstered the housing industry, driving up home values and generally reflating the economy. But now, the teaser rates on many mortgages, particularly subprime mortgages to borrowers with shaky credit histories, are adjusting much higher. As a result, mortgage delinquencies and foreclosures are creeping higher, and remaining home values are under pressure.

Put simply, now we’ve got a hangover from the credit binge.

Starting in June 2004, the Fed incrementally raised rates by a quarter-point 17 times, until it settled at 5.25 percent in June 2006. Since then, there haven’t been any moves up or down.

Until recently, I was among the minority that thought the Fed might hold off a little while longer before cutting rates. I found myself nodding in agreement with those arguing that both lenders and creditors who speculated with easy money in the housing market needed and in some cases deserved to suffer as the market settled back into equilibrium.

Speaking personally, I’m fine with seeing housing values — including my own — ease back a bit to reality as the market clears excess inventory. After all, it’s been a great run, even though the local market never got wildly out of line. I’m also not looking to sell any time soon, and a calmer market should keep my property tax bill from soaring during the next reassessment cycle.

Now, however, I’m sold on a rate cut.

Here’s why: jobs.

The August jobs report revealed that total payroll employment nationwide shrank by 4,000 during the month, marking the first such decline in four years.

That was the clearest sign yet that those problems in the housing and credit markets are spreading to the broader economy. In recent weeks, Fed officials and others have repeatedly expressed the belief that the housing market problems would remained “contained” and not spread further. They argued that consumer spending would remain solid so long as the job market held up.

That hope is less certain now.

Moody’s Economy.com Inc. noted after the August numbers came out that payroll employment has shrunk only five months since 1985 outside of a period of recession.

And although no one is making an official recession call yet, fears of one in the not-too-distant future are rising. The most recent trade on Intrade. com, which lets investors bet on economic and political events, indicates a 55 percent chance of recession by the end of 2008.

Although we might still muddle through without a recession for quite some time, it’s becoming an increasingly narrow thing. So I’m expecting the Fed to cuts rates today by a quarter-point, with more to follow in successive meetings.

We won’t know for months whether the economic medicine will save the patient. But we’ll get some immediate feedback from Wall Street, which has been betting heavily in recent days on a substantial rate cut.

Frankly, at this point I suspect stocks will actually trade lower if the Fed stops at a quarter-point cut rather than the widely wished-for half-point cut. In recent weeks, particularly, the smart guys on Wall Street have sounded a little like the seed-cap folks I grew up with down on the farm.

There’s always something to complain about.

To reach Chris Lester, assistant managing editor-business, call 816-234-4424 or send e-mail to clester@kcstar.com.