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President George W. Bush announces the nomination of Ben Bernanke as Chairman of the Federal Reserve, replacing Alan Greenspan upon his retirement in January 2006. The announcement was made Monday, Oct. 24, 2005, in the Oval Office. |
The Federal Reserve has cut its key benchmark interest rate from 2.25% to 2.0% - a reduction of 3.25% since September 2007.
The rate setting Federal Open Market Committee (FOMC) concluded two days of meeting in Washington DC and earlier a report on the US economy showed that but for inventory building, the annual rate of GDP growth in the first quarter would have been negative.
The FOMC statement (see below) did not signal a pause in rate cutting but at 2%, there isn't much flexibility left and it is likely not to be dissipated unless really warranted.
Trading in futures markets predicted that the Fed would cut its key fed funds overnight lending target by a quarter-point, to 2%, and hold the line there in coming months.
The European Central Bank's benchmark rate is 4%; Japan's 0.5%; Australia's 7.25%; UK 5%; China 7.47% and Iceland 15.5%.
Bill Gross who manages a multi-billion bond fund at Pimco, wrote in his monthly investment outlook for May: To be brief and blunt, the reason that home prices are so critical...is that they are at the forefront of potential asset deflation. Because the U.S. and selected other economies are now substantially asset-based and dependent on stable and upward tilting prices, a deflation of an economy’s primary financial asset can be ruinous.
Gross says that additional policy measures are required to support home prices which have fallen by 10% over the past 12 months and are set for a repeat by this time in 2009. However, he says that further interest rate cuts would, in PIMCO’s opinion, likely do more damage than good from this point forward.
Foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result. The better alternative is to initiate a limited mark-to-market write-down of private mortgage debt as envisioned in the Dodd-Frank Congressional proposal combined with government-subsidized loans at below market rates. Look at it this way: you can allow a home to fall in price from $400,000 to $300,000 and force an upside-down "short sale" foreclosure, or you can reduce the homeowners’ $400,000 mortgage to $350,000, refinance the loan through the FHA at 4% and stabilize the neighborhood and its home prices. Surely Republicans, Democrats, AND Wall Street mortgage holders (PIMCO included) can recognize that stability as opposed to freefall market clearing is the better alternative, especially if the pain is shared by all parties. It is our best chance to cushion Minsky’s asset-based deflation.
Other policy initiatives such as the Bank of England’s 100 billion dollar term funding of their own mortgage market as well as the continued potential for U.S. agencies or the Fed to participate in similar maneuvers are promising alternatives with a unified objective in mind: support home prices. A continued housing deflation of several trillion more dollars now threatens to impact the real economy which in turn might produce a reversal of financial market fortunes.
Merrill Lynch's North America economist David Rosenberg expects second-quarter gross domestic product to fall 2.3% from a year ago, in the first quarterly contraction of US economic output since the 1990 recession.
FOMC Statement
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.
Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.
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