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Fed's actions may wind up hurting in the long term
By CHRIS LESTERThe Kansas City Star
That’s the scenario as the Federal Reserve gathers today to ponder its next move in a financial minefield pockmarked by a struggling economy, a grinding credit crunch and troubling signs of inflation.
Fed Chairman Ben Bernanke and his colleagues, who have caught plenty of grief for failing to recognize sooner the mess we’re in, have been pushing every button within reach in recent months.
They’ve slashed short-term federal funds rates from 5.25 percent to 3 percent since September, including two cuts totaling 1.25 percentage points in a matter of days that gave off the faint whiff of panic. Today, most folks expect the Fed to cut rates at least another half-point, to 2.5 percent.
In theory, at least, all those rate cuts should be filtering through the economy any time now, encouraging struggling households to restructure existing debts at lower rates or luckier folks to borrow new money to pursue their happiness. In theory, lenders would be happy to lend lower-cost money and pocket a tidy profit.
So far, at least, it hasn’t worked out that way. Credit markets have been seizing up all over the place.
The subprime mortgage industry, which pumped untold billions of dollars in credit into the hands of a lot of folks who probably shouldn’t have gotten a loan in the first place, has been eviscerated — and rightly so.
But bonds that were backed by suddenly sketchy mortgages are still stuck in the gullets of masters of the universe on Wall Street. And they’re not in the mood to lend new money to anyone until they know what the underlying housing collateral backing those bonds is worth and they write off losses.
It’s a messy business, hardly the sort of thing that’s going to be resolved overnight. We won’t see things turn until the nationwide housing market bottoms out and recovers. And depending on conditions in widely disparate local markets, that will probably take anywhere from six months to two years.
It’s a buyer’s market, all right — assuming you’ve got the money to go shopping.
One of the most interesting things to watch in recent weeks has been how the spread has widened between the yield on 10-year Treasuries and the mortgage rates that are typically pegged to that government paper.
At this writing, the yield on 10-year Treasuries has been pushed all the way down to 3.42 percent as spooked investors have sought a safe haven for their money. It’s an incredibly paltry return for savers and investors.
Meanwhile, the Mortgage Bankers Association reported last week that the average borrowing cost on 30-year fixed-rate mortgage was 6.37 percent, up a whopping 0.39 points from the previous week.
That’s a big spread compared to recent years, reflecting the renewed fear factor of risk that pervades the credit markets. And it’s going the wrong way for folks who are hoping mortgage rates will come down, give them a chance to refinance or help support the housing market, particularly during the spring buying season.
No doubt, the Fed has noticed. And it’s pushing Bernanke and friends to take some pretty exotic steps to inject liquidity into credit markets that go beyond tweaking short-term rate cuts.
Last week, for example, the Fed offered to let financial firms swap some types of beaten-down mortgage-backed securities, albeit at discounted prices, for up to $200 billion in more-liquid U.S. Treasuries. The theory is lenders will loosen up if they’re allowed to exchange musty mortgage-backed securities for easy-to-sell securities of more certain value.
It’s an interesting, creative idea that more narrowly focuses on the source of our problems than wielding the cudgel of cutting the federal funds rate. The move inspired a brief relief rally on Wall Street.
There’s a reason why the Fed is turning to more exotic tactics to deal with the credit crunch. There’s a growing realization that simply cutting the federal funds rate could actually do more harm than good over the long run.
Consider this. Every Fed cut does a little more to undermine the value of the dollar, which has traded in recent days at an all-time low against the euro and a 12-year low against the yen. That makes the price we pay for dollar-denominated imports — like, say, crude oil — that much more expensive.
So, one price we may pay for dealing with our struggling economy and grinding credit crunch in the traditional fashion threatens to be an even weaker dollar that spurs inflation on what we pay at the pump and the grocery store every week.
It’s a minefield out there, folks. Step lightly.