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SOURCE: Federal Reserve/Rich Clabaugh–STAFF |
Fed's main task: Save the banks
Aggressive moves to cut interest rates by America's central bank are intended to stave off a financial meltdown.
from the February 1, 2008 edition
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The big picture also includes what central bankers call "risk management." Fed Chairman Ben Bernanke and his colleagues consider where the greatest risks to the economy lie – whether on the side of inflation (with too much monetary stimulus) or contraction (with too little money supply).
At certain times, they'll emphasize mitigating the biggest risk they see. Right now, that's the risk of an unhealthy banking system.
Wall Street, broadly defined to include banking and related industries, plays a vital role in supplying credit to consumers and businesses. If the flow of credit tightens more dramatically, the result could be a deep recession, rather than the mild slowdown for the US economy that many economists now predict in 2008.
Even in mild form, a recession could be hard on Main Street, with unemployment rising amid slack consumer demand. "There are three things that worry the average consumer or household," Mr. Goldstein says. "Their job, their job, and their job."
In Wall Street, signs of trouble
Most financial firms are weathering the storm. Yet signs of trouble abound:
•In a recently published analysis, economist Gary Shilling counts 210 US mortgage lenders that have closed, curbed operations, entered bankruptcy, or been acquired in fire-sale conditions since 2006.
•Policymakers are increasingly worried about companies specializing in insuring mortgage-related bonds against default. Insurer MBIA Inc. reported a quarterly loss of $2.3 billion Thursday.
•Problems for banks have spread beyond mortgage defaults to include rising delinquencies on car loans and credit cards, and expectations that corporate-bond defaults will rise as well.
Thomas Palley, a Washington economist, says that interest-rate cuts can help banks and financial firms in several ways. Lower rates allow banks to reap a higher profit on new loans, as the spread widens between their own borrowing costs and the rates they charge others.
Also, rate cuts tend to boost the price of financial assets such as bonds. By lowering the cost of mortgage loans, it could also help stabilize a slumping housing market that has saddled banks with record numbers of costly foreclosures.
In a recent post on his website, Mr. Palley calls the latest rate cuts "welfare for Wall Street." That doesn't mean the move is bad for Main Street. But he says America needs to consider how to avoid repeats of this situation, in which the banking industry goes through cycles of taking on excessive risks, and the whole economy suffers as a result. "We need a much deeper and more severe conversation" about bank regulation, he says.
Economists generally say lower interest rates are needed now, but may increase inflation down the road. That's a price the economy pays for "risk management."
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