With the US Federal Reserve almost certain
to cut the target federal funds rate a quarter
point to 2% on Wednesday, its policy statement
will be closely watched for clues as to whether
chairman Ben Bernanke will pause after cutting
rates 3.25 percentage points since June.
The Fed may like to stop cutting rates. So
far, rate cuts have aided homeowners who have
adjustable-rate mortgages and other borrowers with
loans indexed to domestic interest rates; however,
those cuts have not substantially increased bank
lending.
Put simply, no matter the
prevailing interest rate environment, banks are
frozen out of the bond market, where they have
increasingly raised funds over the past two
decades by bundling
loans into securities.
Insurance companies, pension funds and other
fixed-income investors, having been sold
loan-backed securities during the subprime boom
that were more risky and worth less than the banks
selling them represented, now don't trust the
those banks.
Despite changes in the
leadership at some major financial houses, banks
have done little to win back that trust.
Similarly, the bond rating agencies seem wedded to
cozy relationships with banks, accepting payments
from banks to rate securities the banks create.
The US trade deficit, in particular the
rising oil import bill and stubborn deficit with
China on consumer goods, is a drag on domestic
demand equal to 5% of GDP. The decline of the US
dollar against the euro and other
market-determined currencies has helped; however,
oil is priced in dollars, and the dollar continues
to be 40% or more overvalued against the yuan and
several other Asian currencies.
Until
Bernanke addresses structural problems in bank
participation in securities markets, something
proposals for market reform put forward by the US
Treasury and G7 group of leading industrialized
nations do little address, adequate bank credit to
power an economic recovery will not be
forthcoming, and unemployment will rise.
Until Bernanke challenges the Treasury on
trade and exchange rate policies, the trade
deficit will pose a similar constraint on the
economy. In this decade, as the trade deficit
grew, consumers cut savings and borrowed more
through the banks, shoring up domestic demand.
Essentially, Americans spent 105% of what they
earned, keeping the economy growing, but that
house of cards has now collapsed.
Bernanke
must take on genuine banking reform and currency
and trade policies or his job is impossible. The
latter are outside his portfolio, but past Federal
Reserve chairman have voiced concerns about
federal budgets, entitlements and other policies
that made their stewardship more difficult.
For now, Bernanke seems more comfortable
courting Congressional Democrats by focusing on
consumer lending practices, abuses by mortgage
brokers, appraisers and credit card companies.
This enhances the likelihood of his reappointment
by a Democratic president.
However, if he
continues this tack, he will ultimately find his
name inscribed in history, not along side Paul
Volcker and Alan Greenspan, who conquered
inflation and facilitated great prosperity, but
rather along side the likes of Arthur Burns and G
William Miller, who, though politically adroit,
gave us The Great Inflation and economic malaise.
Peter Morici is a
professor at the University of Maryland School of
Business and former chief economist at the US
International Trade Commission.
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