Fed Officials See Threat To Growth In Sub-Prime Mess

Source : The Business Times, September 12, 2007

Concrete risks of broader slump pose downward pressure on economic activitye

WASHINGTON) Three senior Federal Reserve officials said on Monday that the turmoil in housing and mortgage lending had begun to threaten the overall economy, a condition policy makers have said is the crucial test for deciding whether to lower interest rates at their meeting next Tuesday.

A Fed governor, Frederic Mishkin, told an audience in Manhattan that the risk of a broader downturn 'cannot, in my view, be ruled out' and 'poses an important downside risk to economic activity'.

In unusually direct language for a Fed policy maker, Mr Mishkin said that inflation pressures had become less of a problem - a judgment that, if embraced by other Fed officials, would remove a major argument against lowering interest rates.

'I believe that the risks to the inflation outlook have become more balanced,' he said, 'given the greater downside risks to real growth'. Mr Mishkin is a relatively new member of the Fed board, but he was a well-known specialist in monetary policy at Columbia University with longstanding ties to the chairman of the Federal Reserve, Ben Bernanke. In 1997, while Mr Mishkin and Mr Bernanke were university professors, they wrote a book that called on central banks to base policy around a public target for inflation.

In speeches on Monday, two other Fed officials sent a similar message. Janet Yellen, president of the Federal Reserve Bank of San Francisco, predicted that the housing decline would probably continue and would impose 'significant downward pressure' on consumer spending.

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, admitted that an unexpectedly bleak unemployment report on Friday made him more worried about a slump. Neither Mr Lockhart nor Ms Yellen are currently voting members of the Federal Open Market Committee, which sets interest rates. But both sit in on the meetings.

On Wall Street, the debate among analysts was no longer about whether the Fed would reduce rates but by how much.

Several analysts predicted that the central bank will lower the Federal funds rate, for overnight loans between banks, by half of a percentage point, to 4.75 per cent from 5.25 per cent. Until a few days ago, most analysts were betting on a quarter-point cut.

Fed officials in their comments said nothing about how much they wanted to lower rates.

In Monday's speeches, given before the central bank begins a week-long silent period ahead of its policy meeting, several made it clear they now see concrete risks of a downturn.

In Atlanta, Mr Lockhart went so far as to retreat from a more optimistic stance he had taken a few days ago. He said last Thursday that he had not seen any 'conclusive signs of weakness in the broader economy'. On Monday, he delivered the same speech but acknowledged that he had been jolted by last Friday's surprisingly dismal report that the economy had shed 4,000 jobs in August.

In her speech, Ms Yellen said that a housing downturn and tighter credit were likely to cause 'significant downward pressure' on consumer spending and thus on economic growth.

'The financial market turmoil seems likely to intensify the downturn in housing,' she predicted. Even if investors overcome some of their fears, mortgage rates are likely to remain higher on a long-term basis and could continue to push housing prices down. -- NYT