The Federal Reserve threw up its hands and officially “exhausted its most fundamental tool for managing the economy,” as the Washington Post puts it. The central bank cut its benchmark interest rate to as low as zero and announced that it would aggressively move to implement new programs to fight the recession. The Fed went further than many expected and cut its target for the overnight federal funds rate from 1 percent to a range of zero percent to 0.25 percent. The Wall Street Journal also points out that the discount rate, which is the interest rate that banks have to pay on loans they receive from the Fed, will drop to half a percentage point, “a level last seen in the 1940s.” What does this mean? “For the foreseeable future, interest rates are nearly meaningless as a tool of economic policy,” the Los Angeles Timesbluntly states. The New York Timesand LAT both say the announcements mean that the Fed has now officially entered a new era.
Although it may be shocking and historic that the Fed would cut a key interest rate from 1 percent to nearly zero percent, the truth is that the move is largely symbolic. For weeks, the federal funds rate has been trending far below the 1 percent target. The “difficulty in managing the rate may be one reason the Fed, for the first time, gave a range for its rate target,” notes USA Today. “They’re at such a low level that it’s gotten really hard to control the funds rate,” an economist tells the WP. “This cut is essentially saying ‘Let’s get this over with.’ ” In an accompanying statement, the Fed made it clear that it’s ready to use unconventional means to help American consumers and businesses get credit. Investors liked what they heard and sent the Dow Jones industrial average up 4.2 percent.
In its statement, the Fed made it clear that it won’t be shy about printing money to thaw the frozen credit markets. Essentially, “the Fed is stepping in as a substitute for banks and other lenders and acting more like a bank itself,” the NYT helpfully explains. In normal times, the Fed can spur spending by lowering its official rate. But this hasn’t been working well for months because even though the official rates are low, banks remain fearful about lending money. The Fed now says it is ready to expand efforts to buy mortgage-related securities and is exploring whether to purchase long-term Treasury bonds, which could help lower long-term borrowing costs.
The WSJ says Fed officials came to their decision after two days of meetings where lots of time was devoted to other steps the central bank could take to fight the recession. Federal Reserve Chairman Ben Bernanke spent much of his academic career studying these questions, “and the Fed is now employing almost every prescription he laid out in the past,” notes the WSJ. Of course, the new strategy carries risks. There’s no guarantee that it will work, and, as an added bonus, it could create higher inflation. But officials aren’t too worried about that now, particularly since the consumer price index plunged 1.7 percent in November, a new record. The dollar fell sharply yesterday for the second straight day, which, as the NYT points out, reflects a fear that there could soon be lots of freshly printed dollars in the markets.
President-elect Barack Obama used the Fed’s announcement as an opportunity to tout a massive stimulus package. “We are running out of the traditional ammunition that’s used in a recession, which is to lower interest rates,” Obama said. “It is critical that the other branches of government step up, and that’s why the economic recovery plan is so essential.”
While the rapidly declining prices have brought about fears that the nation will fall into a deflationary spiral, the NYT’s David Leonhardt says the trend could actually help ease the pain of the recession. The reason for this is what economists call the “sticky-wage theory,” which says that businesses won’t cut wages during an economic downturn. Pursuing such a move is seen as such a big morale killer that most executives prefer to lay off workers. Although workers are likely to take indirect pay cuts, the drop in prices means real income of those lucky enough to still have jobs won’t be dropping too much and could “soften the blow” of the recession for many American families.
In another sign of the toll that the recession is taking on Americans, the WP reports that welfare rolls are surging for the first time since the system was redefined more than a decade ago. This trend is notable because welfare rolls usually don’t see much increase during economic downturns. Now, welfare rolls are climbing in at least a dozen states. Some think this means that “welfare will awaken from years as a political issue so sleepy that President-elect Barack Obama did not mention it during his campaign,” notes the Post. When welfare was redefined, a lot of emphasis was placed on finding jobs, but now many of those applying for assistance are people who used to live a comfortable middle-class existence and can’t find work at all. Many of those signing up for welfare “shouldn’t be receiving assistance if there [were] jobs out there,” one Maryland official said. “The problem is, what we are seeing here is something that looks more like 1936 than 1996.” Not surprisingly, several states decided to use the welfare money for other purposes during the economic boom and now risk running out of funds.
The Securities and Exchange Commission acknowledged yesterday that it had been warned several times about red flags in Bernard Madoff’s investments but failed to uncover what could end up being the largest financial fraud in history. The SEC will immediately open an internal investigation to try to figure out why it failed to investigate these warnings. In a front-page piece, the WSJ notes the investigation will examine the relationship between a former official at the agency and Madoff’s niece. The former official, who headed one of the teams that looked into the investment firm, married Madoff’s niece last year. But a representative of the former official says their relationship began “years after” his examination of Madoff.
The NYT gets word that the White House has written up more than a dozen memos to help guide Obama if an international crisis breaks out before he gets a chance to settle into the Oval Office. The contingency plans lay out several possible scenarios, including a cyber-attack and a North Korean nuclear explosion, and outline steps that Obama could consider. These contingency plans are on top of the dozens of memos that the Bush administration has drafted to outline issues that Obama’s team will have to deal with when it gets to the White House. Administration officials are careful to emphasize that they’re just trying to be helpful and in no way intend to dictate policy. “It’s not exhaustive, and it’s not exclusive, and it’s not prescriptive,” a White House spokesman said. Members of Obama’s team appreciate the effort that Bush is making to ensure a smooth transition in a time of war. “This doesn’t absolve the Bush administration of some of their judgments they’ve made over the years, but this is the right thing to do,” one Democrat said.
Things aren’t so lovey-dovey in other parts of the transition. The WSJ notes that transition officials are already discussing how to undo several Bush measures relating to abortion and reproductive health. While several issues are being discussed, it’s still not clear which Obama will prioritize, but it seems to be a safe bet that one of his first actions will be to lift Bush’s limits on embryonic stem-cell research. Abortion-related issues could be thornier since the president-elect has suggested he wants to strike a middle ground.
When the country says goodbye “to its sports-obsessed president who doesn’t like tough questions,” it will welcome “another sports-obsessed president who doesn’t like tough questions,” writes the Post’s Dana Milbank. When Obama introduced his pick for Education secretary, there was lots of talk about basketball but, taking several cues from the Bush playbook, the president-elect refused to answer any questions about the scandal that has engulfed Illinois Gov. Rod Blagojevich.
“I have no sympathy for Madoff,” writes the NYT’s Thomas Friedman. “But the fact is, his alleged Ponzi scheme was only slightly more outrageous than the ‘legal’ scheme that Wall Street was running, fueled by cheap credit, low standards and high greed.” After all, it was legal for banks to give risky mortgages to people who couldn’t afford them, bundle a group of them into bonds, and then receive premium ratings for these bonds. “If that isn’t a pyramid scheme, what is?”