Lower Interest Rates

October 15, 1998

Margaret Warner is joined by Dean Foust and Neal Soss to discuss the cut in short-term interest rates by the Federal Reserve Board.

ELIZABETH FARNSWORTH: The surprise move by the Federal Reserve is first. Margaret Warner has that. MARGARET WARNER: Why did the Fed act, and what might be the consequences? Some answers from Neal Soss, former Vice President of the Federal Reserve Bank of New York. He's now chief economist of the investment firm Credit Suisse First Boston. And Dean Foust, who covers the Federal Reserve and international economics for BusinessWeek Magazine. Dean Foust, today's move by the Fed seems to have caught almost everyone by surprise. How unusual was it? DEAN FOUST, BusinessWeek Magazine: Very unusual. This was the first time the Fed had moved between meetings - and the Fed meets about eight times a year. The first time it moved between meetings in four years. And truly one of the hallmarks of the Greenspan Fed has been not to surprise the market, certainly not by unexpectedly raising rates, but even not with an unexpected cut in rates, as it happened today, because certainly the reaction of some on Wall Street was oh, my God, things must be worse than we thought if Greenspan is moving between meetings. But he did it to send a signal: one, the gravity of the situation with the economy and second, to create a certain urgency that he does care and he will do what it takes to keep this economy from going into recession. MARGARET WARNER: Neal Soss, you're also a former - we didn't say this - but a special adviser to then Fed Chairman Paul Volcker. So you've been on the inside. Does this - the way this was done convey to you that there was a special sense of urgency? NEAL SOSS, Credit Suisse First Boston: Yes, indeed, it does. The record in the Greenspan years in particular has been increasingly to act only at meetings only with very substantial forewarning, and I think the action that was taken a few weeks ago - that ¼ point drop in the Fed Fund's rate in late September - was greeted by the markets as conveying a sense of complacency at the Fed, rather than the urgency that perhaps the situation actually requires. So today was really a very good theatrics of catching up. MARGARET WARNER: All right. So let's talk a little bit more about why. What did they really hope to - first of all, what was troubling the Fed the most? The Fed mentioned growing caution by lenders and unsettled conditions in financial markets. I mean, translate that for us. DEAN FOUST: As the - go back to last fall when we had the Asian economic crisis that devastated countries like Thailand, Indonesia, Korea. It spread into Russia, and as it spread into Russia during the summer, investor psychology on Wall Street and in the global markets started to change, and particularly as it spread into Latin America, and that's when a lot of lenders, a lot of investors really started to circle the wagons, fearing that it was inevitable that it would hit the U.S.. And they stopped lending to all but the best borrowers out there, so a lot of marginal borrowers - a lot of companies found it increasingly difficult to either get credit, and if they could, at very high interest rates. MARGARET WARNER: Now, you're talking about here in the United States. DEAN FOUST: In the U.S. but in other countries as well. And so you had - I mean, it's like FDR's old line that we have nothing to fear but fear itself. The fundamentals of the U.S. economy remain relatively good, very low unemployment, very low inflation, and very high productivity. Wages are going up, but there was this fear that was starting to build and affect the way lenders - so this was - Greenspan's like the cop who steps out at the accident and says, folks, there's nothing to see here, go back to your homes. He's saying that the fundamentals of the economy are sound and go back to your lending, go back to your businesses, I'll do what it takes to make sure that this doesn't get out of hand. MARGARET WARNER: Neal Soss, what would you add to that as to why? NEAL SOSS: Well, you know, we've seen a sequence of financial revelations, revelations about major financial institutions, some of them household names. Some of them are rather obscure until they hit the newspapers. What was going on there was the equivalent of a global margin call. You know, a banking institution is a bit like a store. It has to have an inventory of securities on the shelf to sell. It supports that. It owns those inventories by borrowing money. And increasingly, in the last few weeks, we've seen challenges to the ability of some of these core financial institutions to borrow that money and carry those inventories. And that sort of thing is precisely what central banks are designed to prevent that kind of financial instability. MARGARET WARNER: And how much would you say the problems that some of these hedge funds have been having lately contributed to this? NEAL SOSS: Well, that's certainly one illustration of this same phenomenon. Some commercial banks have made revelations about their involvement with hedge funds. You've been reading about this in your newspapers. That sort of thing is at the core of the responsibility of the central bank, and it was the first thing that the Fed mentioned in the announcement today. MARGARET WARNER: Dean Foust, we've seen some other interest rate cuts from Britain, I think, last week, and Spain. Is this part of a coordinated global interest rate strategy, and what do you think is going to be the impact globally of today's action? DEAN FOUST: I think there will be some other countries whose central banks do cut rates. I think we can expect a cut by the Bank of Canada. I think the Bank of England is likely to cut rates. But - and it will allow the central banks in the emerging economies in Asia and Latin America to bring down their interest rates as well, but maybe not much more. In fact, that's been one of Greenspan's frustrations. In my conversations with officials at the Fed, I got the sense that they would like to have engineered a global, coordinated, synchronized rate cut with the central banks in Europe and around the world. But they got resistance from Europe because of this phenomenon where Europe is trying to move toward this single currency next year with a single interest rate. And so the banks in France and in Germany have been very reluctant. In fact, they have to coordinate their rates. They have to raise their rates to bring them in line with those. So, Greenspan finally took it upon himself that he'll lead the charge here. MARGARET WARNER: Neal Soss, what do you think is going to be the impact on the global markets? NEAL SOSS: Well, this is very reassuring news. You know, there was a story just this week in the newspapers about the placebo effect -- the idea that just having a doctor come, sit by your bedside, perhaps hold your hand, and tell you that the doctor is alert to the symptoms, cares about the patient, and all the rest, can by itself help improve things. And I think the Federal Reserve sent an extraordinarily well executed signal in that regard today. And this was a circumstance in which the financial markets were I think reasonably concerned that perhaps the central banks didn't fully appreciate the difficulties that the core financial system was creating for itself. The core financial markets have now been reassured that the doctors there, the injection has been given, so to speak, and it's okay to feel a bit better. I think we're going to see this resonate all around the world. MARGARET WARNER: All right. And staying with you for a minute - NEAL SOSS: And favorably so. MARGARET WARNER: How do you think it's going to resonate here at home? There were actually two interest rates that were cut today. Explain briefly or simply to laymen among us, first of all, what's the difference between them and which, if either of them, could have a more immediate impact on American businesses and American consumers? NEAL SOSS: Well, the discount rate is the rate at which the Federal Reserve, the nation's central bank, lends to banking institutions that for whatever reason can't get themselves fully funded in the markets. That's a rather specialized sort of thing I think from a layman's perspective. That's got a big announcement effect. It's got a certain drama to it. But it doesn't affect your viewers, so to speak. The Federal Fund's rate, which was also reduced today by ¼ percent, is the rate at which banks lend overnight to one another. It's a rate that the Federal Reserve can influence and does influence through its own daily purchases and sales of government securities. That rate is the one that sets a base for the prime rate, which is used in pricing home equity lines, small business loans, and the like, and we're likely to see the prime rate come down ¼ percent first thing tomorrow morning, so I think that's going to give tangible purchasing power relief. But I think the issue here is really more important than that. As Dean was suggesting earlier, we have seen some American corporations and companies and countries around the world that in recent weeks really couldn't get access to credit in the normal commercial way. If this signal from the Fed reopens those markets, it's vastly more powerful than any ¼ percent in terms of, so to speak, the arithmetic of interest rates. It's vastly important for reviving the ability of the world economy to do what it's supposed to do, to grow, to deliver job opportunities, and all the rest. MARGARET WARNER: And Dean Foust, again, back to impact here at home, the market went up, the stock market, 330 points. Do you think that's just a blip? Was that - or was that warranted? DEAN FOUST: I think we'll have a rally certainly tomorrow, and it'll probably carry us into next week. I think the Fed picked a good day. I mean, if you really want to get inside baseball, the Fed picked a day where the market was already rising. Had the Fed announced it was going to cut interest rates on a day when the market was down 200, that really could have set off this reaction of, oh, my God, it's worse than we thought, the Fed is jumping into the breach. We'll see a rally tomorrow, because there was a lot of - a heavy short position. Tomorrow is a big auctions expiration day, and we could see more rally - the stocks rally into next week as well. MARGARET WARNER: And, briefly, do you think the Fed next meets for a regular meeting November, I think, 17th - do you think we'll see more and another rate cut? DEAN FOUST: The fact that they brought the discount rate down lower than the Fed Fund's rate by ¼ point signals that they believe there's more room to move. They could. It depends on what happens in the economy and the markets between now and then. MARGARET WARNER: Okay. Great. Thank you both very much.

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