Fed tries to grease the economy's wheels
The Federal Reserve's move to sharply ease interest rates may have injected some confidence into the financial markets. But there's one problem: The Fed can't force lenders to open the credit spigot wider.
Mortgage-related losses and consumer loan delinquencies have so far defied the Fed's efforts to ease the raging credit crisis. The fear now is that even the Fed's most aggressive effort to date may not succeed in getting more money into the hands of businesses and consumers fast enough to curtail the economic slowdown.
And if it doesn't? A trifecta of problems - a housing slump, high energy prices and tightening credit - could inflict more pain. Consumer spending, the engine of the economy, may slow further. Businesses could lay off more workers. And the nation could find itself in a full-blown recession.
The rate cut "may help to some small extent, but this is one of those times where there are forces tugging in different directions," says Joel Naroff, founder of Naroff Economic Advisors in Holland, Pa. "If we continue to have (these) major credit restrictions, that's obviously going to slow the economy further. ... You have a good chance of recession."
The Fed's rate cut succeeded in calming jittery investors, who had begun the session with a binge of selling. But it's too early to tell whether the cut will ease the woes of the nation's banking system and lead to increased lending to consumers.
Bank of America and Wachovia, two bellwethers of the industry, reported dismal earnings. Bank of America's profits for the fourth quarter plunged 95 percent from the prior year's; Wachovia's earnings fell 98 percent.
In a conference call, Bank of America's Ken Lewis said, "This has easily been the toughest environment since I've been CEO." He added that he didn't expect a rosier outlook anytime soon.
As long as the credit crisis goes on, it will remain difficult for banks to package consumer loans and sell them to investors, says Lyle Gramley, a former Federal Reserve governor who is now a senior economic adviser at Stanford Washington Research Group. "And because they're writing down assets, they're losing capital" to make new loans, he adds.
Restored confidence in the credit markets would encourage lenders to ease their loan standards, Gramley suggests. That hasn't happened in the past, in part because the fall in home sales and prices has made it hard for banks to price their assets. And despite a succession of rate cuts, the Fed had sent mixed messages about whether it would continue to cut rates.
But Tuesday's action, Gramley says, could build confidence because the Fed conveyed its intent to focus mainly on the credit crisis' impact on the economy.
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