Economy Ignores Fed's Lowering Of Interest Rates

THE Federal Reserve Board, broadly perceived as the only government shop with the tools to direct United States economic policy, may not be up to the job.It's not for lack of trying. The Fed has reduced interest rates four times since last December, including last week's decision by Federal Reserve Board chairman Alan Greenspan to ease rates again. Now at 5 percent, the Fed's discount rate - the interest rate it charges when commercial banks borrow from the central bank - is at its lowest level since 1973. The federal funds rate, the overnight lending rate banks charge each other, was cut to 5.25 percent. But lower rates have failed to spur the kind of economic activity necessary to push the US economy out of recession. Sen. Donald Riegle Jr. (D) of Michigan, chairman of the Senate Committee on Banking, Housing, and Urban Affairs, blasts the Fed for action "that is long overdue," and "not good enough." He calls on commercial banks to follow-up on the Fed's action by lowering their prime lending rates to consumers. Lower rates alone will not lead to economic recovery, says the Michigan senator, especially for Americans out of work. Unemployment in his state, home of the ailing US auto industry, is 9 percent. Lower consumer confidence about the present and future has kept brakes on consumer spending, which accounts for two-thirds of US economic activity. Banks, almost unwilling creditors due to huge loan losses, are far more restrictive in their personal and corporate loans. Marco Babic, a senior financial analyst with Evans Economics, a Washington-based forecasting and advisory service, says the future overall credit picture does not look bright. Consumers will continue to exercise the same caution they have for the past 12 months, as long as unemployment continues to hover around 7 percent. Consumers' reluctance to spend means they can save more and borrow more, Mr. Babic says. "They may buy more expensive, higher-quality products, which will increase US production."

Stocks kept lean Businesses have kept their stocks lean during the past year of recession. "They have largely worked off their inventories, so any increase in demand will mean more production. But I don't see any raging recovery," says Babic. Fed-watcher Christopher Whalen, a financial consultant with the Washington-based Whalen Company, says: "Banks and people alike aren't selling anything. Whether it's a white-collar employee who's living off his savings or a medium-sized business saddled with debt and unable to expand, the economy's going to be flat for a long time." A primary reason, says Mr. Whalen, is that banks don't have capital. "They're staring at losses. No matter how low rates go, they're not going to be willing to extend the credit. They don't have the money." Walker Todd, currently on leave as assistant general counsel to the Cleveland Federal Reserve Bank, agrees. Despite Americans' tendency to save more, he says, "bank deposits are dropping." Lower rates provide lower yields on deposits. This, coupled with bank failures all over the country means "people don't want to put their money in banks," says Mr. Todd. "They're putting their money elsewhere. For example "savings bond sales are at a record high," he says. The housing market is a closely analyzed barometer of economic activity; it reflects consumer spending and affects a host of related industries - from building materials to home furnishings. The industry's most troubled region, the East Coast, won't be affected much by the rate drop, says Warren Lasko, executive vice president of the 2,300-member Mortgage Bankers' Association of America. "Ninety percent of our mortgages are 30-year fixed mortgages. Only 10 percent are adjustable-rate loans that would be affected by the lower short-term rates." The market is already favorable, he says. "Mortgage rates are low and housing prices are pretty flat all up and down the East coast. People are nervous. When they are concerned about future employment, they are less likely to go out and buy a home." There is some speculation that the Fed will lower rates again in the near future, further ripening the conditions for borrowing.

Caution advised Todd cautions against nationwide interest-rate reductions, which he says are driven by regional, East Coast concerns. While the residential and commercial real estate markets are a drag on Northeast, he says, other parts of the country are rebounding. He points to Midwestern agricultural districts now in "mild recovery" and industrial areas in the Midwest and California that are on the upswing. "National interest rates should reflect the entire country, not just one region," Todd says. He opposes any further easing of rates, pointing to the dangers of capital flight - the flip side of borrowing made easier by lower rates. "We are playing a dangerous game," Todd warns. "Whenever interest rates become low and the core rate of inflation [the inflation rate minus energy and food - two mercurial sectors of the US economy not factored into the core rate] is high, it's only natural to see funds flow offshore to seek higher returns, such as in Japan or Germany." The US government relies heavily on foreign investments to finance its soaring operating costs.