Cheering and Jeering The Fed’s Rate Decision
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
The Federal Reserve chairman, Ben Bernanke, was no doubt toasted by some last night and roasted by others. The decision to cut interest rates by a quarter point will have infuriated those who see the swoon of the dollar (which yesterday neared an all-time low against the euro) as an affront to “truth, justice, and the American way”, to quote Superman. On the other hand, those trying to line up credit or get access to the commercial paper markets, which are still in disarray, will breathe a mite easier.
At first glance, it would seem an odd time to cut interest rates. The Commerce Department reported third-quarter growth of 3.9% yesterday, the fastest in several quarters. Gains came from a resurgence in consumer spending, up 3%, and a nice uptick in capital spending, which rose 5.9%. Both measures were well ahead of prior-quarter levels.
One of the most buoyant areas of the economy was exports, which were ahead 16.2% in the quarter. This sector is showing a powerful and inevitable response to the slide in the dollar, and has recently proved one of our greater engines of growth.
Why, then, should the Fed cut rates? Because the credit markets are still tight, and the higher cost of financing will inevitably have an impact on economic activity down the road. This is true in real estate and in other sectors as well. “It’s not that money is gone.” John Estreich, head of Estreich & Company, one of the city’s top mortgage brokers, says. “But, the ability to access it is different and the cost is different. And, it’s very difficult to obtain large loans.” According to Mr. Estreich, the cost of borrowing has shot up, mainly due to higher spreads and the need to put up more equity. “You can’t borrow 85% to 90% on deals any more,” he says. “Now you have to put up 25% to 35% equity.”
The CEO of CB Richard Ellis, Mary Ann Tighe, confirms this trend: “You need much more equity now. The whole loan to value equation has shifted dramatically.”
Mr. Estreich points out that before the credit crunch this past summer, the easiest loans to procure were those of more than $500 million. Because the largest lenders were able to securitize such borrowings and quickly spin them out to investors, deals were done in record time. That door has closed, and with it the megadeal financing.
Does this shift in the credit landscape mean that real estate is dead? No, but it almost guarantees a slowdown. Since real estate projects have such long lead times, the turn in credit markets is not much visible yet in commercial real estate activity, but will doubtless show up in coming months.
Even more important, the disruption in the supply of commercial paper to industry has eased of late, but is still not totally recovered, according to a senior banker in the space who agreed to talk off the record. He says most investors have no idea how serious the shutting down of credit was for companies reliant on such short-term borrowings. “Big investors in commercial paper are still nervous, and very defensive,” he says. “They are not buying commercial paper except in very small amounts.”
According to Federal Reserve data, asset-backed commercial paper outstanding reached an all-time high of $250 billion by midyear, having increased steadily from $130 billion in early 2004. This source of funding collapsed to less than $180 billion in a matter of weeks as buyers became skittish about credit issues.
The first Fed cut eased the seize-up in commercial paper issuance, but the market is still considered fragile, and is doubtless one reason that the Fed chose to cut rates further.
Arguing against the rate cut was the Fed’s concerns about inflation. At the moment, most indicators of price pressures are relatively benign. Yesterday’s release from the Bureau of Labor Statistics showed that the employment cost index in the third quarter was about the same as in the second, with total compensation costs for civilian workers up 0.8%.
This positive news on labor rates could be undone by rising energy prices. Oil prices have been making headlines of late, with speculators driving the price above $90/ bbl. Although industry data suggests that the rise in price could begin to slow or even reverse demand growth, the escalation will work its way through to the consumer’s pocketbook in coming months. Still, overall, price increases are moderate. The latest reading on so-called core inflation showed a rise of 1.8% in the third quarter, higher than the second quarter figure of 1.4%, but still within the Fed’s targeted range. The other objection to a further easing of rates comes from those who are concerned about the decline in the value of the dollar. Some view the exchange rate as symptomatic of the nation’s financial health, and perhaps its global influence. The Fed, it appears, takes the view that a declining dollar poses a lesser threat to the nation’s economy than does turbulence in the credit markets.
It also may view the consequent reversal in the trade deficit as profoundly beneficial. For decades America has seen its manufacturing industries head overseas in search of cheaper labor costs. Today, there are signs that some industrial production may find its way back to the U.S., where the cheaper dollar has driven down costs. The dollar is not the only boost to America becoming more competitive. The recent labor agreements reached by auto makers and the UAW hold out the prospect that all-in labor costs are not as burdensome as they were several years ago.
If indeed the hike in exports proves to be more than temporary, the dollar, most would argue, will take care of itself.
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