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Last updated: December 17, 2008 09:57am Fed Trims Key Rate to Zero By Erika Morphy
WASHINGTON, DC-These are trying economic times in a modern economic environment, so it is little surprise that the Federal Reserve Bank has taken unprecedented steps in trying to curb calamity. The Fed decided to down-size the Federal Funds Rate from an already low 1% to between 0.25% to zero. The industry had been expecting a modest 25 or even 50 basis points trimmed away from this key rate. Fed officials, including Fed chairman Ben Bernanke had been sending out mixed signals of late over their intentions--promising on one hand to use all tools available, and then noting on the other that the Federal Funds interest rate was dropping too low to be an effective recessionaryfighting instrument. Clearly, though, the “use all tools” school-of-thought won out with Tuesday’s decision by the Federal Open Market Committee. Not only was the decision to cut the rate to this level unanimous but FOMC all but said it would keep rates at this level for as long as necessary. We anticipate “that weak economic conditions are likely to warrant [an] exceptionally low level of the federal funds rate for some time,” it said in a prepared statement. Furthermore, it added, the Federal Reserve will continue to consider ways of using its balance sheet to support credit markets and economic activity. Given that the Fed has already been fighting this recession very aggressively, it is difficult to imagine what else it could do. It could focus more on quantitative easing, Peter Cohan, principal with Peter Cohan & Assoc., tells GlobeSt.com. “Basically that means, [the Fed] next try to set longer term interest rates-- the federal funds rate is short term. To do this they would essentially flood the markets with longer term money.” Like the cuts to the Federal Funds rate, though, Cohan says this would be pointless. “The Federal Funds rate, after all, was hovering around 5% some 18 months ago. It has been steadily dropping to zero, to little effect in the economy.” Indeed, the commercial real estate industry has met each interest rate cut with a collective shrug. The cuts have done little to affect and industry which has been grappling with a credit crunch for the last 18 months. This time, though, might be different. Zero percent is essentially free money, and that is bound to have an impact in the lending market. It may well be that with money this cheap lenders will finally be inspired to begin lending again. “A downward movement in the Fed Funds rate is meant to induce more 'risk-taking' on the part of the lenders, because the returns on other assets become more attractive relative to a risk-free return,” Villanova School of Business professor Scott Dressler, tells GlobeSt.com.
Villanova School of Business 2008 Media Report