The Federal Reserve cut interest rates on Dec. 11th on hopes that the credit crisis would be tempered from 4.5% to 4.25%. Markets were on the upswing up until the cut was announced because many investors were under the impression that the central bank, under pressure from all sectors of the economy especially real estate, would deliver a heftier half-point cut, which would have made it significantly less difficult for banks to borrow money from the Fed for their day-to-day transactions.
While the rate cut was still welcome from all fronts, the quarter-point cut disappointed many investors, resulting in a 200 point drop in the New York Stock Exchange within a matter of minutes. Consumer confidence is at a five-year low, reflected in markets around the world. However, the extreme volatility of recent months has been as much a function of investor skittishness as of the credit crunch itself. While most of the sub-prime mortgage fallout has been focused within the real estate market, investors who are uncertain of market conditions will be less likely to invest more, thereby limiting growth.
If the Fed had taken a different approach to their sole mechanism for assisting economic growth, investors would, in all likelihood, have a much better disposition. Over three months they have cut the rate a total of one percentage point, each cut instigated by liquidity difficulties and the sub-prime woes. Now credit is barely more available, and the only plan offered to circumvent the housing slump is laughably inadequate and initiated by lenders. Nothing significant has changed, except that oil prices have fallen from their incredible highs to a slightly less incredible high, and that most Americans are worried even more about their homes.
A concentrated drop of one percentage point in one month could have signaled a much more decisive Fed, restoring faltering consumer confidence through a message saying that effective measures exist and will be taken. By diluting the interest rate cuts over a fiscal quarter, the potential gains to be made by the resulting rate are less impressive, especially on a spooked market.
Fortunately, another rate cut is on the horizon, probably in January. Thus they are able to reduce rates without making a serious statement in regards to the uncertainty investors feel, and in fact exacerbate its results on the market, as shown in the recent cut. Yet their course does ensure that change will occur, even if not in the form and timeliness one might expect.
Another concession to recent events comes in the primary discount rate cut, which helps boost the amount of currency available for banks to lend to each other, from 5% to 4.75%. With projected growth estimates all 1% down for 2007, and since the estimated 2 million defaults from sub-prime mortgages have yet to be realized on the marketplace, the Fed seem to be taking any precautionary measure they can, short of decisive action. By responding only when it appears like everyone else in this troubled financial climate, they don't fully understand what the fallout could do to the larger economy.
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