Fed Still Faces Tough Fight Against Recession: Experts

The Federal Reserve’s interest-rate cuts will do little if anything to help the mortgage and housing industries in the short-term--and the central bank is just at the beginning of a long, hard fight to head off a recession, experts say.

Most economists and banking industry analysts agree that the Fed’s half percentage-point cuts in the fed funds and discount rates signal that the central bank sees collateral damage from the real estate slump. They also show that Fed chairman Ben Bernanke has gained the upper hand in managing Wall Street’s expectations.

Federal Reserve Board Chairman Ben Bernanke.
Pablo Martinez Monsivais

“It was an insurance policy to cushion the economy from the devastating affects of the credit crisis,” says economist David Jones, president and CEO of DMJ Advisors.

Jones points to a striking difference in the Fed’s position on economic conditions and the credit crunch in its Aug. 7 and Aug. 18 FOMC statements and what it said in its Sept. 18 rate-cut statement.

“Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time,” the FOMC said.

Promoting moderate growth over time, however, may not be that easy to sustain. A growing number of economists now think the Fed has a fight on its hands when it comes to recession. All three of the economists interviewed for this story expect the fed to cut rates one--if not two--times at its October and December FOMC meetings.

"Pushed for Bigger"

“The Fed did this for the economy, not knowing what the economy needed,” says Robert Brusca, Chief Economist at Fact & Opinion Economics. “Bernanke pushed for the bigger rather than the smaller cut.”

Brusca says another decline in non-farm payrolls, as was the case in the August data--a turning point in the recession debate--will bring another cut, sooner or later this year.

“This is just the beginning.” Adds Nouriel Roubini, a professor at NYU’s Stern School of Business and chairman of Roubini Global Economics. Roubini, who served on the President’s Council of Economic Advisors, says the Bernanke Fed has been behind the curve for a while and a recession is almost a forgone conclusion at this point.

One clear reason for that is the housing market, which Roubini says is continuing to deteriorate. For some time, he has maintained that prices will fall 20% from their 2006 peak. The Fed’s rate cuts won’t help, given the size and duration of the bubble.

Banking analyst Bert Ely agrees on both counts. “I question how much effect it is going to have in the short term, says Ely, who runs his own firm. “What we have in housing is a classic inventory problem. It takes a while to work through an inventory cycle.”

"Help Some People"

“A half point cut is going to help some people, but there’s a still a lot of people, particularly in the parts of the country where you’ve had a drop in house prices and job cuts ... (in those places) it isn’t going to help a lot in the short term.”

The job market – which was seen as strong until the August payroll report in early September  – was often seen as one clear positive in the housing market equation. But layoffs in the mortgage and housing industry have hurt on a national basis.

The Fed’s unmistakably clear focus on the declining health of the economy, economists say, also erases any misperceptions about whether the rate cut was meant as a bailout to lenders and borrowers.

“You can’t bail out subprime borrowers by cutting the fed funds rate by 50 basis points," says Brusca.

Brusca and Jones say not only are the Fed’s intentions clear, Bernanke’s stock has also risen sharply. The days of second-guessing the once-untested Fed chairman and talk of the Wall Street forcing the Fed boss into a reactive mode are probably over.

"He's on a Roll"

“We got some really good insights into Bernanke,” says Jones, a veteran Fed watcher. “He really had his ultimate test. He’s on a roll. It was a brilliant tactical move to let the Street think the Fed might not do anything and then cut the way he did.”

That move may also dampen the critical comparisons with the policies and practices of his predecessor Alan Greenspan.

“Greenspan arrested problems at a very early stage,” adds Brusca. “Bernanke comes in after the problem. His view is not to prevent the damage but make sure it doesn’t spread. He’s not looking to bail out the people who made the mistakes. He’s trying to change people’s expectations."

By most accounts, Bernanke accomplished that and more Tuesday.