TOPICS > Economy

Wall Street Suffers Bad Day Over Fears of Stalling Recovery

August 11, 2010 at 12:00 AM EST
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Major indexes on Wall Street gave back more than two percent of their value Wednesday over concerns about the strength of the U.S. economy. Gwen Ifill discusses the plunge and the Federal Reserve's acknowledgment that the recovery has slowed with The Washington Post's Neil Irwin and Nightly Business Report's Tom Hudson.
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JIM LEHRER: Markets fell sharply today amid fears that a global recovery may be stalling. It was the worst day for Wall Street in more than a month. All three of the major stock indexes dropped by at least 2 percent into negative territory for the year. More than 2,600 stocks on the New York Stock Exchange lost ground today.

The Dow Jones industrial average closed down 265 points at 10378. The Nasdaq fell more than 68 points to close at 2208.

Jeffrey Brown has more about the drop and the numbers that set it off.

JEFFREY BROWN: Stocks began falling this morning after investors took a closer look at the Federal Reserve’s latest projections that the economic recovery is weakening.

In a statement issued yesterday, Fed officials wrote, “The pace of recovery in output and employment has slowed in recent months. Growth,” the statement said, “is being held back by high unemployment, modest income growth, lower housing wealth, and tight credit.” In addition, “bank lending has continued to contract.”

Today, the Fed announced an initial response, saying it would buy $18 billion worth of long-term government securities, the aim, hold down interest rates, making it cheaper for consumers and businesses to borrow money.

This afternoon, President Obama tried to talk up one of the bright spots of the past few months: a rise in the number of manufacturing jobs, following a long plunge during the recession.

U.S. President BARACK OBAMA: So overall, the manufacturing sector has actually added 183,000 jobs so far this year. That’s the strongest seven months of manufacturing job growth in more than a decade.

Instead of plants leaving America to set up shop overseas, we’ve actually begun to see the opposite — a growing number of firms setting up shop and hiring here at home.

So we’re not yet where we need to be, but there are some good trends out there. And we can’t let up. We’ve got to keep moving forward.

JEFFREY BROWN: The president’s remarks and the Fed’s actions came after a disappointing jobs report last Friday.

And for a closer look at all this, we’re joined by Neil Irwin, who covers the Fed and economics for The Washington Post. He joins us tonight from Chicago. And from Miami, Tom Hudson, co-anchor of “The Nightly Business Report” on PBS.

Tom, so the Fed puts out just a few paragraphs yesterday, and markets clearly didn’t like it today. What did they see? Fill in the picture for us.

TOM HUDSON, co-anchor, “The Nightly Business Report”: Well, what they saw were concerns building in China and elsewhere about the global economy continuing to hit the brakes. The Chinese markets continue to try to price in a slower economy over there. That’s awfully important for U.S. exporters. We saw that in the trade figures earlier today.

And rethinking the Federal Reserve assessment of the economy through the end of the year has the markets — has certainly shareholders in the stock markets worried as we see lots of folks piling into the risk-off trade, and that meant buying U.S. government bonds ahead of what the Federal Reserve has promised to do, as you detailed earlier.

JEFFREY BROWN: Now, Neil Irwin, what seemed to get people’s attention was — in part at least — was a perceived change in direction by the Fed. Explain that.

NEIL IRWIN, business reporter, The Washington Post: That’s right.

What — for the last year or so, the Fed has been in exit strategy mode. They have been talking and thinking about how to remove all these supports they put in place for the economy, all the actions they took during the crisis, and, you know, letting programs expire, that sort of thing.

This is a reversal. It’s a small reversal, but it’s a reversal, nonetheless. And what they’re doing, as you mentioned, buying about $18 billion in the next month in treasury securities, and they’re going to keep buying at kind of a low pace, not a massive infusion of cash into the economy.

Part of what was going on, on the markets today is, people in the markets would like to see more. People in the stock market always want to see the Fed doing more to prop up growth, and so they would like to see more large-scale asset purchases than the Fed is really willing to do at this stage.

JEFFREY BROWN: Well, Neil, explain a little bit more about what the Fed is doing, because, for a long time, we have talked about the notion that the Fed really has very little room to do anything, right, because interest rates are already so low.

So, this gets a little complicated, but what’s the mechanics here of the action they take and how it then has an impact on the economy?

NEIL IRWIN: Sure. Because the Fed’s normal policy tool — normally, what they do to manipulate — to manage the economy is they raise or lower their target for short-term interest rates. That’s already at zero. They can’t cut it any further, so they have to turn to other tools.

What those have meant so far is buying long-term securities. So, what they do is they go buy mortgage-backed securities, treasury bonds, other things. So, what they’re doing is, they’re increasing the money supply and reducing long-term interest rates.

That flows through ultimately to what it costs to get a mortgage, what it costs for a corporation to borrow money. So it does have an effect on long-term rates. The problem is, it’s a very unconventional move. They don’t want to do it. It’s not clear exactly what the effects are, how effective it is.

So, they want to be very cautious with these approaches and not undertake them lightly. So, it would take some real worsening in the economic outlook for them to do any more large-scale asset purchases, like they were doing this time a year ago.

JEFFREY BROWN: Now, Tom Hudson, I would like to just dig in a little bit into one of the things that the Fed brought up, because it’s been a persistent issue and problem. And that’s the bank lending and the tight credit issue.

What do — how do you explain it? Is it a supply problem, a demand problem, businesses, banks? Give us the — parse the equation for us. What do you see?

TOM HUDSON: Sure.

Well, the banks will tell you that it’s a demand problem. They will say that they have got plenty of dry powder, plenty of cash ready to lend into a market, assuming that there are people and businesses asking for it. And, by the way, those businesses and people need to be qualified, need to be high-credit quality, for the banks in order to lend that money.

Now, you talk to small-business people and some consumers who may be of questionable credit quality saying they would love to go to a bank to get the money, but they don’t feel confident that in fact they will get the money. So, it’s both a supply and demand constriction at this point.

And, really, it’s unclear, from the market perspective — we saw it articulated today with the 2 percent sell-off, that investors really remain unconvinced that the Federal Reserve actions are going to matriculate down to loosening up of credit and increasing the velocity of money and putting dollars into the pockets of consumers and into the pockets of companies to spend them in the economy.

JEFFREY BROWN: But just to stay to — stay with you, Tom, that issue of lending practices is a direct consequence of what we have been through the past couple of years, right, a question of who gets loans and who qualifies?

TOM HUDSON: Yes, it’s — absolutely. It’s a direct consequence of what we have been through over the past 24 months. Of there, there’s no doubt.

But, also, we have to remember, 24 months ago, our standards of credit quality were much different than historically what we have been at. And so the banks will tell you their — their credit standards have, perhaps, reverted back to where they were before the credit boom days of 2003 to 2007. We were used to very easy credit and being able to get a 30-year, no-income-stated home mortgage with a 500 FICA credit score. Those days are long gone.

Instead, we have reverted back to more normal credit standards. And considering what we have been through over the past several years, it seems like it’s very tight.

JEFFREY BROWN: Neil Irwin, what’s your — what’s your analysis of the credit and bank lending issue?

NEIL IRWIN: Tom hit a lot of the important issues.

The thing is, it takes two to have a loan. It’s not just that banks are unwilling to lend, though they are being more cautious. It’s that businesses are looking around. They don’t see great investment opportunities. They don’t have the confidence to buy more equipment or build a new factory.

So, there is a reluctance on the part of businesses to even apply for a loan or take out a loan right now. But it clearly goes both ways. And even though there might be some banks that are in fine financial shape and ready and willing to — to make loans again, there are plenty of other banks, especially smaller ones around the country, that are still groaning under this weight of loans they made during the boom years to commercial real estate projects, other kinds of lending, that they’re not quite sure whether they are going to get paid back.

And while they have that uncertainty, they’re not willing to take the risk of making new loans. So, that’s hanging over this economic recovery.

JEFFREY BROWN: And, Neil, that of course ties directly to the jobs picture, right, too, because the businesses also are loathe to hire.

NEIL IRWIN: Right. A business that can’t borrow money or isn’t willing to borrow money to build a new factory also isn’t going to hire employees to staff that new factory. So, that’s one of the big dark clouds that is hanging over this recovery that showed some weakness the last few months.

JEFFREY BROWN: Now, Tom Hudson, are their implications here for — and I mean in the Fed action specifically — for the rest of us, not the businesses and the banks, but consumers?

TOM HUDSON: Well, there are implications for those consumers out there who are creditworthy in the eyes of bankers these days. For those who are in the housing market or in the credit — the consumer credit market looking for IOUs, looking to borrow money, what the Federal Reserve action that it announced yesterday and is going to kind of reel off over the next several months, it likely means lower cost of loans, lower interest rates, which clearly is going to be a good thing if you’re interested in that money and if you can qualify for it.

JEFFREY BROWN: And, Neil Irwin, there is one potential downside, I think, that was noticed in the Fed action, which is the fear that it makes it easier for borrowing, and including the government to borrow.

NEIL IRWIN: Yes, what’s happened is the entire strategy is to try and lower rates. Well, the truth is, interest rates are already really, really low in the United States. The U.S. government can borrow money more cheaply than it has almost any time in its history.

And, so, on the one hand, that’s a good things. It keeps rates low for consumers and businesses. It makes it easier for the U.S. government to finance its debt. That has a lot of benefits, but it also — you know, it can’t last and it probably won’t last forever.

JEFFREY BROWN: Tom Hudson, a last word to you on that. I mean, that feeds into the inflation vs. more of what we’re hearing nowadays about deflation.

TOM HUDSON: Yes, a lot of talk about whether or not we’re going to enter a deflationary spiral. In fact, we have seen a regional Federal Reserve bank president in fact mention that D-word within the last week or two, deflation, something that would have been unheard of just a couple of years ago to hear from a Federal Reserve regional bank president.

But I think, long term, the question remains, with all of this cash being flooded into the U.S. economy — and, really, that means the global economy — it can only but perhaps stoke the fires of inflation longer-term. And that’s where you really have to pay attention to market interest rates, not the Federal Reserve interest rate, but what the bond market is telling us.

And, right now at least, there’s no concerns about short-term inflation, but that could turn on a dime.

JEFFREY BROWN: All right, Tom Hudson of “The Nightly Business Report,” Neil Irwin of The Washington Post, thanks, both, very much.

NEIL IRWIN: Thank you.

TOM HUDSON: Thank you.