A Rate Cut on Hold

By Robert D. Novak (THE WASHINGTON POST, 16/08/07):

Before the recent global financial crisis began, the Federal Reserve Board under Chairman Ben S. Bernanke was ready to take a subtle step toward easier money in order to stave off U.S. recession fears. Ready for approval was a new Federal Open Market Committee (FOMC) statement ending the central bank’s neutrality and putting it on a bias for an interest rate cut. But international credit scares changed all that.

The Fed and other central banks moved quickly and in unison last Friday to pump more cash into financial systems, successfully stabilizing markets made jittery by collapsing hedge funds around the world. It was central banking at its best, avoiding “panics” that would have resulted from such a situation a century ago. But Bernanke’s broader plans for easier money have to be placed on hold because he cannot be seen as bailing out greedy hedge fund operators.

The cautious Bernanke shoulders a burden not faced by his often error-prone predecessors. Because of today’s global economy, he is central banker for the world. The latest credit crisis originated in the failure of American subprime home mortgages backing securities held in Europe. The complicated equation that Bernanke ponders also involves the rest of the industrial world growing at a faster rate than the United States, leading some to speculate about tightening by the foreign central banks.

The Fed’s operations are vastly more transparent today than they were in the 1960s, when I first attempted to decipher the secrets of the marble temple on Constitution Avenue. While the FOMC’s decisions now are disclosed promptly, the central bankers do not disclose and try not to leak their plans. However, according to Capitol Hill sources, they had secretly decided to issue a statement soon changing the Fed’s bias toward easing — which no longer would be in neutral.

While such a change in itself can boost the economy, it normally is followed immediately by an actual drop in interest rates. In this case, however, sources indicated that the second step would not come for several months, to coincide, if possible, with good anti-inflation numbers. That would soften the perceived inflationary risk of boosting the economy.

But any kind of easing now — either abandoning neutrality or a full-scale cut in interest rates — could make it appear as though Bernanke was less interested in the broader economy than in protecting millionaire hedge fund operators and traders. The credit crisis began with the collapse of two mortgage-connected Bear Stearns hedge funds, at a cost to investors of more than $1 billion. Central bankers do not want to be regarded as bailing out Wall Street risk-takers.

Bernanke’s primary responsibility for the past week has been to coordinate with his fellow central bankers around the world and avert a global catastrophe. The Federal Reserve, the European Central Bank, the Bank of Japan and the Reserve Bank of Australia combined to put cash into the system. Financial markets calmed, and the dollar rallied after a representative of the People’s Bank of China on Monday called U.S. dollars and government bonds “an important part of China’s foreign reserve investments.”

Even the chairman’s critics commend his handling of the first major crisis in his 18 months on the job. They say the departed “maestro,” Alan Greenspan, would have acted identically — with a single exception, in the opinion of one Fed watcher. He feels that Greenspan would have leaked plans for an interest rate cut in the future to show his overriding concern about the U.S. economy.

Domestic economic indicators released on Tuesday pointed in various directions. On the bearish side, Wal-Mart and Home Depot separately reported profits that were less than expected. On the bullish side, the U.S. trade deficit fell as exports reached new highs. The government reported yesterday that the core inflation rate rose 0.2 percent in July (a 2.1 percent increase for the year) — not clearly showing whether inflation is worrisome enough to inhibit the Fed from easing.

As Bernanke considers his course, the “R” word (recession) is in the air in Washington. That’s why the Fed secretly decided to move away from neutrality toward easing, which is now on hold thanks to the global crisis.