HispanicBusiness

Washington In Action I: The Federal Reserve

After initial reluctance to cut benchmark target interest rates, the Fed has acted aggressively since August. The bank has provided liquidity and decreased interest rates with the goal of stabilizing the financial markets and also offering relief to consumers carrying large debt burdens. Although the Federal Open Market Committee decided on January 30 to lower its target for the federal funds rate 50 basis points to 3 percent, the financial markets do not yet appear to have found their bottom.

The Federal Reserve action is further constrained by increasing inflationary pressures coming from the food and energy sectors, along with a depreciated U.S dollar that has made imports more expensive.

Recent inflationary pressures, together with expectations of the larger budget deficit, have resulted in a perverse decoupling of long- and short-term interest rates, as the graph below shows. While lowered Federal interest rates were pressing downward both 30-year Treasury Bonds and 30-year mortgages, the expectation of higher inflation has started to propel long-term interest higher, despite further aggressive efforts by the Fed. The anticipation that lower mortgages rates was going to alleviate the distressed real estate market appears to be vanishing on inflation and budget deficit spikes.

Washington In Action II: Congress And The White House

In mid-February, President George W. Bush signed a $152 billion plan to stimulate the U.S. economy. The plan, cleared by Congress with unusual speed, uses tax rebates to place spending money in consumers' pockets.

Although consumers account for about two-thirds of the U.S. economy, $152 billion in spending represents just 1.5 percent of the $9,930 billion personal consumption expenditures at the end of 2007. The stimulus impact depends on whether the tax rebate checks are spent or saved. Assuming most is spent, then the stimulus will depend on the portion that is spent on domestic versus imported goods. Unfortunately, consumers will have to look hard on retail shelves for homegrown products. In addition, increasing gasoline prices (at $111 barrel of oil) will eat up part of the checks.

Conclusions

At the end of the fourth quarter of 2007, the U.S economy was growing at a 0.6 percent rate, much lower than the 1.1 per cent expected. Economic growth was only possible because the 0.9 percent contribution of the export sector to the economy. Otherwise, the economy would have shrunk by 0.3 percent. The year 2007 closed with a GDP growth of 2.2 percent, a notch slower than 2006 with 2.9% growth. The U.S. Federal Reserve lowered its most recent forecast for growth in 2008 for the second time in eight months to a range between 1.3 and 2 per cent, down from a projection of 1.8 to 2.5 percent range in October.

Other forecasts for the U.S. economy range from the perfect storm view with a high risk of a systemic crisis, as predicted by Prof. Nouriel Roubini of New York University's Stern School of Business, to the sunny UCLA Anderson Forecast that the U.S economy is not, and will not be, in a recession in 2008. The UCLA forecast, released March 11, indicates that although there will be one-quarter of negative GDP growth, there will not be recession. Further, it expects the housing drag on GDP to dissipate in the second half of the year and the return of a normal economy in 2009. In any case, assuming a crisis is avoided, there are only mediocre growth rates for United States on the horizon.

As we go to print, the Federal Reserve has made a radical policy move by expanding its securities lending program to $200 billion of Treasury securities. As collateral, financial institutions can provide federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The final goal is to provide liquidity to the financial markets, but gets the Fed closer to buying nonperforming mortgage securities. It addresses the symptoms of this financial mess but leaves intact the source of the problem: the unknown quality of the residential mortgage loans. The new Fed measures confirm that lowering interest rates was not an effective maneuver, in resolving economy slowdown. Th is moves the Fed closer to bailing out Wall Street. We should be vigilant that it is not done at the expense of Main Street.