The spreading subprime lending meltdown and a slowing economy prompted the Federal Reserve to cut short-term interest rates by a half percentage point to 4.75% last month.
It was the first Fed cut since June 2003.
“While economic growth was moderate during the first half of the year, the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally,” according to the Fed statement last month.
The hope is the interest rate cut will keep credit flowing and stem a slowing economy.
The Business Journal’s Carol Park asked investment bankers and other finance professionals, “Has the interest rate cut accomplished what it intended?”
Following are their edited comments.
Bryant Riley
Chairman
B. Riley & Co.
Los Angeles
If the intention was to bring stability back into the market in the face of the subprime issues, then the Fed’s absolutely accomplished this goal over the short term.
However, the perception that cutting interest rates is some kind of panacea is short sided. Inflation, a weak dollar and deficit issues are still longer-term concerns. How the interest rate cut affected these issues will be measured down the line.
The market’s strong positive reaction to the Fed’s move has opened the door again to investment to an extent. The larger hedge funds and private equity owners are still a bit cautious, but certainly, everyday the markets continue their hike, confidence is being restored.
Clearly the cut has been positive.
The larger concern in my mind is what happens to the consumer over the next six months to a year. We have seen some negative trends in retail spending outside of the high-end and I am concerned some of these trends are not being given enough attention given the strong positive reaction to the cuts.
Donald Straszheim
Vice chairman
Roth Capital Partners LLC
Newport Beach
The 50-basis point interest rate cut by the Federal Reserve has generally served its intended purpose. In the environment of seriously deteriorating credit market conditions, it sent the message to market participants and the business community in general that Washington was on the case, ready to assure that particular problems in the credit markets did not cumulate into systemic troubles for the economy or financial markets overall.
Yet the Federal Reserve tried to balance these steps with a marketwide sense that they were not simply bailing out investors who had taken undue risks,only to encourage that trouble-making behavior again in the future.
Any decline in interest rates, such as this one, reduces the cost of capital, and naturally tends to lift investment. But that was not the intention of this move. The intention was broader. The issue was to try to avert a broader financial sector problem.
Few people would argue that interest rates, flowing from a targeted 5.25% fed funds rate, were so high that they have choked off investment. The core inflation rate is around 2%, leaving a 3.25% real short-term rate of interest. That is not stifling the economy.
This decline in interest rates has increased lending somewhat, but again this was not the primary intended effect.
With respect to a narrow portion of the housing market and mortgage finance, where the problem originated, the cascading of bankruptcies and failures feared, has not happened. That is a big positive.
Confining the problem to the segment of the market in which loans were made to people with weak credit histories and little record of employment success and stable incomes, yet were given loans on houses they could not afford, was the issue. As time passed and variable rates rose to levels that these people simply could not pay proved to be the undoing of the housing subprime sector.
The banks are happy with this rate cut, both at the discount window and for Fed funds. Investors are pleased, as we have seen in the markets since the cut.
The economy seems to be weakening with employment more sluggish, but overall activity is not too bad.
While not impossible, it would be unprecedented for the U.S. to suffer a significant recession without a current inflation problem and without interest rates at stifling levels.
Business people, unless they are working in a sector associated with the shattered mortgage industry or housing (and attendant service products) are fine. They understandably are worried that the housing problems will contaminate the entire economy, but much of the housing decline has likely already occurred, even if the recovery from these depressed levels is 12 to 18 months in the future.
The cut in interest rates had the effect, likely more than the Federal Reserve might have expected, of lifting fears in the equity markets broadly and igniting a quite wide and robust rally.
Investors seem to be confident in the economy’s future despite the ongoing and deepening troubles in housing.
Murray Rudin
Partner
Riordan, Lewis & Haden Equity Partners
Irvine
While the interest rate cut was favorably received, possibly because of its potential for improving prospects for economic growth, I don’t think it is a big contributor to assuaging concerns about the volume of bad loans in the market.
Those concerns revolve around inability to repay principal, which is not substantially mitigated by a quarter- or half-point drop in rates.
There is some mitigation because of the benefit of lower rates for adjustable rate mortgage borrowers. But it really doesn’t have much impact on the excesses of corporate leveraged buyout loans.
High rates were not the problem. The concern is about the inability of borrowers to pay back the principal.
I don’t think the rate cut has much impact on the pace of lending. Commercial lending has slowed down in recent months, but it is not because rates were too high for borrowers. If that were the case, then lowering rates might increase assessment of the risk associated with placing high levels of debt on businesses.
They have become more concerned as to whether a debt-laded business can really repay all of the principal.
Lower interest rates don’t address that concern.
The only solution to lenders’ current more prudent assessment of risk is for them to offer lower amounts of debt to businesses in order to be more confident that the business will generate enough cash flow to fully repay the debt.
Rick Keller
Principal and chief executive
Keller Group Investment
Management Inc.
I thought the initial cut of the discount rate by 50 basis points was brilliant. The Fed was able to help banks that may have had a liquidity problem, not necessarily caused by problems in the subprime area, without benefiting firms that were part of the problem.
Cutting the Fed funds rate has a broader reaching effect, lowering the cost of funds for all banks and many of their customers. The impact of cutting Fed funds will take some time to work through the economy.
I think it has the desired impact of lowering the borrowing costs for all investors but it will come at a slower pace.
It is too early to declare it a success.
I think we have a couple of concerns still. Although inflation appears to be acceptable, wage inflation has been increasing without productivity improvements that normally keep inflation pressures in check.
The other concern is the impact of employment reductions in housing and related industries and the spillover effect into the rest of the economy.
To date, we seem to be in good shape with the revisions to the August payroll figure, up 89,000 added to the September job report of 110,000 new jobs.
The decline in housing prices accompanied with inventory of foreclosed homes coming on the market will continue to provide pressure on housing prices. This eventually will affect consumers spending habits.
Our biggest concern would be that a recession in the housing industry spills over into the broader economy. Right now I would put that as the less likely scenario. The likely scenario is the economy continues to grow below par at approximately 1.5%.
The Fed’s rate cut decision has eased fear in many investors in that they have demonstrated they are willing to act by lowering Fed funds if they feel the economy is in danger of declining.
Michael Kaye
Founder and managing partner
Clearlight Partners LLC
The stock market has been buoyed by the interest rate cut and for the short term it has had a positive impact. It seems like the Fed is trying to stave off a recession because of the housing problems and to stimulate economic activity.
However, there is a limit to the impact that the (interest rate cut) can have.
The fundamentals of the problems are still there including the housing market issues.
In terms of lending, I don’t think (the cut) had a material impact,it’s still a choppy period. There’s less money to borrow and it’s more expensive.
Glenn Gray
President and chief executive
Sunwest Bank
Tustin
I don’t think the rate cut will have an effect on the subprime issues but the tangible effect has been that it has eased fears. The rate cut provided evidence that the Fed was concerned about the increasing anxiety within the market, however, I do not think it will have any other meaningful impact.
