The Federal Reserve Board cut short-term interest rates twice in January, most recently to three percent. The cuts are meant to encourage consumers by making credit more available, and to rally plunging stock markets. But financial experts note that the risk of lowering interest rates is price inflation: the cost of living rises and the dollar buys less. A New York-based hedge fund owner and a professor of economics shared their views on the likely results of these moves.
Thomas Cooley, a professor of economics at New York University and dean of its business school, said he thought the Fed’s latest action was a step too far. “The concern is that as you continue to inject liquidity into the system, you unleash the inflation genie from the bottle,” he said in an interview. “And once you do, it's very hard, it's painful to control it again.”
Cooley supported the Fed’s earlier, emergency cut in January, however. That cut, he said, “brought interest rates down so that consumers who have to refinance or who are holding significant amounts of debt, if they can get a mortgage, the rates are fairly attractive.” Cooley said the U.S. economy is fundamentally sound, and will recover from its current slump within the year.
Hedge fund owner Patrick D’Angelo, who formerly ran equity trading at Dresdner Bank, is more pessimistic, both for the markets and the economy as a whole. He says the U.S. is already in recession, or close to it, and the rate cuts aren’t helping. “If the market's not rallying on the back of these massive rate cuts, what's going to cause the market to rally?” he asked. “The reality is that nothing will. This is nothing more than what you call a dead-cat bounce,” he said, referring to the brief rallies immediately following the rate cuts.
D'Angelo said that requirements for home loans have tightened so much now that even low interest rates cannot resolve the housing slump. He forecasts a long-term slowdown in the U.S. “It's not as dire as a depression, but I think we'll be in a sustained recession for I would say, minimum three to five years,” he said. “And the reason I say that is that it's all going to be based on real estate, and the financial crisis that we're going through. Banks right now are not so much insolvent, but there are a lot of issues. Just because they're getting capital infusions doesn't mean their business is going to get better as a result.”
Cooley said he’s encouraged by the banks’ accounting for their losses so far, and by their new capital, but said, “It’s a precarious time. I think there are more losses that we’re going to experience, that we’ll see further adjustments, further write-downs.”
Both analysts said that Europe’s economy, and its big banks, could be the next hit. “Most of the U.S. financial institutions now are pretty well-capitalized,” Cooley said. “But we might see more problems emerging in Europe and other places which have relied more heavily, many of the European banks have relied more heavily on these off-balance sheet structures.”
”I personally think the U.S. is better positioned than most of the Western Europe countries,” said D’Angelo. “I think the big shoe to drop is actually going to be in Western Europe. Maybe the U.K. won't be as bad, but Germany, Italy, France, Spain, Portugal, all the European community is in dire straits right now. And I don't think people see this yet.”
If there is a recession in the United States, many developing countries will feel it, too, both analysts said, particularly the U.S.'s largest trading partner, China. India, on the other hand, could benefit, according to Thomas Cooley, if American companies outsource more jobs in response to a slowdown.