The Sluggish Federal Reserve

In recent months, fallout from the sub-prime mortgage scandal has been estimated in the hundreds of billions, up from figures of $100 billion maximum from the Federal Reserve only three months ago. While the Fed has, in an unprecedented move, cut interest rates three consecutive times in as many months, their cuts have always given investors the impression that a later cut was inevitable, cycling in a self-fulfilling prophesy that has played out poorly for the American economy as investment and stocks have been relatively cool. This behavior reflects a prevalent attitude that the situation will get worse before it gets better, and that uncertainty is the single biggest enemy of economic growth.

An interesting point of comparison for the Fed's actions in recent months is to use other central banks, such as the European Central Bank (ECB) and the Bank of England (BoE). These banks have taken a somewhat different tact against the sub-prime problems. As early as August, the ECB and BoE decided to tighten lending standards and require that potential borrowers be have informed consent, so as to avoid a repeat problem of this magnitude. The Fed had to be threatened with losing their ability to set policy in a similar fashion for them to take action. When they did, their rules did not apply retroactively in any respect to the predatory loaning, but it did at least set some precedent for responsibility in the mortgage market.

These actions beg the question: Why is the Fed so darn sluggish? At nearly every turn, the US central bank has taken too little action far too late. All of their rate cuts have been anticipated like thunder after the lightning starts a massive forest fire. Their one response that wasn't completely acknowledged beforehand was the joint decision by the major banks to inject billions into the financial system overnight, which only worked because it was such a concerted effort.

These circumstances bely an important aspect of the Fed's ability to help guide the economy: Sometimes a surprise is in order. The only reason for the Fed's reticence against a large, definitive rate cut is because of the ever-present threat of inflation. Yet as oil reaches the $100- a- barrel mark and food and commodity demand consistently outstrips supply, it seems their ability to exercise control over inflation seems a bit dubious. Granted, this scenario is without precedent, but so would be a 1% Fed cut in a single day. The difference is that a cut of that size would send a message that the economy is in real danger, but that the Federal Reserve is capable of taking that threat seriously and in a timely fashion- something that they have obviously failed to do in recent months.

Their single remaining hope is that the sub-prime crisis will not be felt as heavily outside of the money markets it has already impacted, but as credit card companies and other financial institutions that have no primary connection to the crisis have begun complaining that, if people can't pay their mortages, they probably won't be able to pay their mounting credit card bills, the Fed's options seem increasingly limited. If nothing else, hopefully recent events will stimulate quicker action on the part of Bernanke and associates.

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Escapesomewhere is a company working in Austin Texas. Their site provides information about Austin real estate along with a Austin MLS search. They also provide insights on the Austin market on their Austin real estate blog.