The US Federal Reserve cut short-term
interest rates half a percentage point in mid-September to make it
cheaper for banks to provide loans and keep the crisis in the subprime
mortgage market from spreading to other sectors of the economy.
cut was bigger than many market analysts had expected and was designed
to have an immediate impact on interest rates for home loans, credit
cards and business borrowing.
credit crunch is the first major test for Fed Chairman Ben Bernanke and
not all the experts agree on whether Bernanke has got it right.
Forbes, the billionaire publisher and a former US presidential
candidate, called on the Fed to cut rates by one full percentage point
to get banks and the economy past the immediate credit scare. He says
Bernanke and the other Fed governors are too worried about being
accused of bailing out the banks and borrowers that are responsible for
the current problems.
“If our own central bank does what a central bank should do and gets
over the hang-ups over who you help (and) who you hurt. Deal with the
crisis, get on with it and adopt a stable monetary policy in the
future,” he said.
Ilian Mihov, INSEAD professor of economics, thinks the Fed has been prudent and that
making a more drastic cut in rates now could cause bigger economic
much more symptomatic of problems in the economy so making sure that
inflation is on track or in the right range is much more important and
serious than to keep asset prices from bubbling or trying to address
movements in asset prices,” Mihov said.
There has been a sharp rise in defaults and foreclosures on riskier
subprime mortgages. Many mortgage lenders that offered low, teaser
rates have adjusted those rates upwards making it difficult for some
borrowers to meet their obligations. Many economists aren’t sure how
much worse the crisis might get and whether it might infect the rest of
'Uncertainty is the great killer'
Bernanke took over at the Fed from the venerable Alan Greenspan. Just
this week, Greenspan admitted that he hadn’t expected the problems in
the subprime market or the resulting credit crunch. He said the issue
was difficult for banking regulators to curb.
Federal Reserve Chairman
thinks the Fed took the problem too lightly under Greenspan and that
Bernanke’s Fed has been too slow to act. Forbes watches gold and
commodity prices and indeed oil and commodity prices surged after the
rate cut. Forbes and some other economists expect additional rate cuts.
is the great killer at a time like this,” Forbes said. “Thanks to
securitization, everyone owns subprime mortgages even if they don’t
know it. (If) you have a money market fund, some of that commercial
paper may be backed by subprime paper.”
disagrees. He thinks the Fed has done the right thing. Mihov admits
that he may have some bias. He was a student of Bernanke’s and thinks
his former professor has done an “excellent job.” He believes that
since the Fed has only one instrument of monetary control: interest
rates as it has to watch inflation.
position has its backers too, with some economists worried that
lowering rates too far, too fast could put more pressure on an already
weak dollar and could provide even more fuel for rising oil prices.
its statement released along with the rate cut, the Fed governors
didn’t indicate where rates were headed. It noted some risks of
inflation but uncertainty about the economic outlook.
“Economic growth was moderate during the first half of the year, but
the tightening of credit conditions has the potential to intensify the
housing correction and to restrain economic growth more generally,” the
Fed said in a statement.
Only a small percentage of mortgages in the US are subprime, but the
housing boom was a major contributor to growth in household incomes in
recent years and any slowdown threatens consumer spending. There was a
knock-on impact as well as banks became wary about loaning to all but
the best borrowers. That’s wreaked havoc with banks and businesses
around the world.
financial sector has a very important role in matching lenders and
borrowers, so if the Fed sees there is a process of disintermediation,
which means lenders put their money in banks, but banks do not lend to
borrowers, so the intermediaries do not fulfill their function, then
the Fed knows this a very serious problem and the real economy will
suffer,” Mihov said.
is more critical. He told the Singapore Press Club shortly before the
Fed meeting that Bernanke should stop acting like Hamlet and start
acting like a central banker. “It will be felt. It shouldn’t be a
disaster but it will have a little bit of impact. But the key thing
is, the sooner the Fed gets its act together, the better we are all
going to be.”
Republished with permission from Knowledge@INSEAD
the online research and business analysis journal of INSEAD.