Federal Reserve Chairman Ben Bernanke's emergency interest-rate cut this week is either just what the doctor ordered or grounds for malpractice...
Federal Reserve Chairman Ben Bernanke’s emergency interest-rate cut this week is either just what the doctor ordered or grounds for malpractice, depending on which prominent economists and investors you consult.
Stanford University professor John Taylor says the move “made sense,” and Harvard University’s Martin Feldstein calls it a “very good thing.”
Morgan Stanley’s Stephen Roach counters that the decision was “dangerous, reckless and irresponsible,” and Nobel Prize winner Joseph Stiglitz says it resulted from “bad economic management.”
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The divergence of views stems from the timing of the reduction, coming on Tuesday — less than a day after stocks tumbled from Hong Kong to London, raising prospects of a slide in U.S. markets.
While Bernanke has warned of the danger that “fragile” markets pose to the slowing economy, some analysts say he risks rewarding investors who simply made bad decisions.
“By easing aggressively on the basis of no new information, they’re sending a message that they have to protect and defend the markets,” Roach, Morgan Stanley’s Asia chairman, said this week at the World Economic Forum meeting in Davos, Switzerland.
The reduction in the benchmark federal-funds rate by three-quarters of a percentage point was the largest in the two decades that it has been the principal tool of policymakers.
While the Standard & Poor’s 500 index lost 1.1 percent the day of the Fed’s interest-rate cut, it has since rebounded more than 3 percent in two days, ending a five-day losing streak. The index is still down 14 percent since touching a record in October.
Traders anticipate a further half-point rate cut at the Fed’s meeting Jan. 29-30. That would put the overnight interbank lending rate at 3 percent and bring the cumulative reduction to 2.25 percentage points in less than five months, the deepest cut since 2001, when the U.S. entered its last recession.
This week’s change in rates was the first between meetings since 2001 and the closest to a Federal Open Market Committee gathering in 16 years.
“I am concerned that they moved a week before a scheduled meeting, seemingly in direct response to global equities, and that sets a bad precedent,” says Mickey Levy, chief economist at Bank of America in New York.
By contrast, former Fed governor Lyle Gramley says that “this was a necessary move, and highly desirable.” Up until this week, Bernanke and his colleagues were “timid,” he says.
“The Fed just didn’t recognize the severity of this crisis and therefore didn’t act in a timely fashion,” says Gramley, now a senior economic adviser at Stanford Group in Washington, D.C. “Had the Fed not done it, it would have been considered not just in a slumber but in a coma.”
S&P 500 futures had slumped as much as 5.3 percent before the Fed’s 8:20 a.m. announcement on Jan. 22 amid a global investor exodus from stocks.
On Thursday, Société Générale said a rogue trader caused a $7.2 billion trading loss at the Paris-based bank. It started unwinding positions linked to European stock-index futures on Jan. 21, though Philippe Collas, the head of asset management at the bank, said “it’s not possible” that caused the slump in equities.
Fed policymakers didn’t know about the loss before their decision to reduce rates, a Fed official said Thursday on condition of anonymity.
“The key issue for the Fed is the U.S. markets and the U.S. economic growth, and from this perspective we have had problems for some weeks now,” says Christophe Donay, head of economic research and investment strategy at Landsbanki Kepler in Paris.
“The cut is not the problem,” Donay says. “The communication is key. The Fed has to explain clearly to the market why it did what it did in order to avoid a panic scenario. From this point of view, the Fed still lacks clarity in its speeches.”
Others stress that the magnitude of the Fed’s action will be what counts.
“Everyone is criticizing the Fed, but they lowered the cost of capital by 18 percent,” says Dan Genter, who helps manage $2.8 billion as president of RNC Genter Capital Management in Los Angeles. “That is going to be an overall life preserver to the economy, and it is a huge dose of antibiotics to the financial sector.”
The Fed’s unscheduled move has been a frequent topic of discussions in Davos. Billionaire investor George Soros said the Fed is “doing the right thing,” just not quickly enough. “I think the Fed is well behind the curve, and has been reacting instead of being proactive,” he said.
“The Fed rate cut showed that the Fed can be pushed around by the markets,” says Nick Parsons, head of market strategy at National Australia Bank’s NabCapital unit in London. “The Fed is a follower and not a leader. In an attempt to gain control, the Fed has lost credibility.”
By lowering rates by three quarters of a percentage point in one go, the central bank may be leaving itself less room to maneuver as the outlook develops, says Mark MacQueen, partner and portfolio manager in Austin, Texas, at Sage Advisory Services, which oversees $5 billion.
“The 75 basis-point cut was too much too quick,” MacQueen says. Bernanke didn’t get “enough bang for his buck. He used a lot of ammo for very little reward.”
Feldstein said in testimony to the Senate Finance Committee on Thursday that the Fed should reduce its main rate by “at least” a half point next week. At the same time, the idea of separate fiscal stimulus “deserves attention” because of the risk that rate cuts won’t be as effective as in the past.
“The Fed has been aggressive and has been helpful,” David Rubenstein, co-founder of buyout firm Carlyle Group, said in an interview in Davos. “Probably, had it done what it did a little bit earlier, it might have been more helpful to the markets. But I think the key is the stimulus package.”