October 3, 2001 MARKET PLACE Cheap Credit, Except for Those Who Need It Most By FLOYD NORRIS
The Federal Reserve made it cheaper yesterday for some people and companies to borrow. But its efforts to stimulate the economy are being hampered by a plunge in consumer confidence and by financial markets that are hesitant to provide money to the companies that need it the most. "The Fed easing is not very effective at the moment, because there are powerful things working against the Fed," said Jan Hatzius, an economist at Goldman, Sachs. He pointed to a sharp drop in business investment and said it would probably continue. The Fed's action cut the overnight rate on lending between banks, and was immediately followed by cuts in bank prime rates, which will in turn reduce the rates on some corporate and consumer loans, notably home equity lines of credit. That lowering of costs will save money that may be spent. The cut was the second since the attacks on the World Trade Center and the Pentagon three weeks ago, but since then the effective rates for companies with lower- quality credit, so-called junk-bond rates, have risen as investors have grown more worried about an economic slump and a possible increase in corporate bankruptcies. Borrowing is cheaper for companies with good credit but not for others. Similarly, in the last week, share prices of high-quality companies have recovered a good part of the losses recorded in the week after trading resumed following the attacks. Lower-quality companies have recovered much less and face greater problems if they try to sell stock. Broadly speaking, companies raise capital for two reasons, because they need the money to pay bills or because they want to make investments that appear attractive. Markets are not eager to provide cash to those who need it the most, and the volume of investment spending has fallen sharply from peak levels because some industries, notably telecommunications and technology, have excess production capacity. That glut is not likely to ease soon, and it is probable that investment spending will follow, not create, an economic recovery. Still, Wall Street reacted positively to the Fed's cut, and the Dow Jones industrial average closed up 113.76 points. "As my grandmother would have said, it couldn't hurt," said Paul L. Kasriel, the chief economist of Northern Trust (news/quote) in Chicago. "It's very likely this will, with a lag, stimulate borrowing and spending in the economy." The economy was probably in recession before the attack, which has shocked companies into making layoffs that many had delayed and seems to have paralyzed consumers, at least temporarily. Just how long those factors will continue is far from clear. "Planning horizons of everyone we talk to seem pitifully shortened in a manner wholly out of character for such a dynamic economy," said Robert V. DiClemente, an economist with Salomon Smith Barney. When the shock begins to ease, assuming that there are no new shocks, lower interest rates are likely to have a greater effect. Many on Wall Street expect that the federal funds rate, the rate at which banks lend to one another and which the Fed can control, has farther to fall. It is 2.5 percent, having been cut from 6.5 percent in the Fed's round of nine cuts. At least one more Fed move, to 2.25 percent, is anticipated this year, and some think the rate will be cut to 2 percent. Fiscal stimulus, through additional government spending or tax cuts, is also considered likely and is deemed desirable by many economists. For much of the 1990's, consumer optimism played a crucial role in helping the economy weather shocks like the Russian debt default in 1998. Industrial production has now fallen for 11 consecutive months, but surprisingly strong consumer spending kept the economy growing, albeit at a very slow rate, before the attack. Surveys indicated that consumer confidence was fading even before the attacks. The guess now is how far confidence will fall before it starts to rise, and when that rise might begin. It is not something that anyone is forecasting with confidence.
