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June 22, 2001
This troublesome patch for the economy has been unlike any other post-Depression downturn, and with every passing day the ensuing recovery appears to be unique, as well.
Beginning with... what recovery?
Great optimism -- especially in stock market circles -- that Fed easing will inevitably bring a strong economic recovery does not square with the Fed's continuing need to take extreme measures.
The Fed will ease again next week, at least .25% and possibly .50%; the larger move would take the Fed funds rate to 3.50%, down from 6.50% in only six months in what is already the most dramatic rate-cutting campaign in the Fed's history. Thus far, the Fed's cuts in its short-term rate have not benefited mortgages at all. However, as this peculiar episode unfolds, the chance for a mortgage visit to the sixes is increasing.
A normal recession begins with the economy overheating into inflation, which the Fed stops by slowing the economy with high interest rates. A normal recovery begins when the Fed reverses itself by easing credit, and credit-sensitive industries lead the economy back out of trouble.
This time, there was no increase in inflation when the Fed began to raise its rate in 1999. In February 2000, Mr. Greenspan got into terrible trouble by admitting that the over-bubbled stock market was the target of his rate hikes. At the peak of the Fed's tightening in May 2000, and during the seven months following, before it began to ease, the Fed's rates were not high enough to harm housing, autos, consumers, stock market margin borrowers, or any other credit-sensitive sector.
The economy cracked in the fall of 2000 in a weird confluence of blown stock market bubble, an undecided and unhappy Presidential election, and a collapse in capital spending on New Economy fantasies.
The stock market may have been Mr. Greenspan's target, but in retrospect, I don't think he hit it. The Fed's modest tightening didn't blow the stock bubble: it blew under the pressure of it's own grotesque overconfidence in absurd business strategies.
Which leaves us short of recovery: the Fed can't undo what it didn't do in the first place.
The Fed can ease more -- will ease more -- but housing is already at capacity, and the nation's appetite for autos and other consumer goods is already strong. There isn't a thing in the world the Fed should or can do for Nortel or Level3, or to help the AOL vs. Microsoft scramble for king of the internet scrap heap.
The economy will recover, but it will take time. The longer an earnings-poor stock market stumbles, the farther returns on cash fall and the longer they stay low, then the more attractive mortgage yields will look to investors.
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