Federal Reserve & Interest Rates

Federal Reserve Board Governor Mishkin gave a testimony this morning about the availability of credit to small businesses.  Apparently, things are not looking very good.  The economy as a whole has been gradually improving, according to the Governor, however, he warns that there could be a possible negative turn ahead for those seeking small business loans.

Generally, as for just about any borrower are this time, credit is very likely to be less available and more expensive for small business owners.  It is logical to suspect, since recent actions have been taken to prevent credit crunch, loan seekers may have a difficult time obtaining funds.

This is not a definite prediction.  Governor Mishkin phrased it like this: “I emphasize that the possible effects are complex, that we do not yet have much hard evidence, and that it is far too early to draw any definitive conclusions. Thus, my comments should be viewed as preliminary and subject to an unusually high degree of uncertainty.”

Evidence suggests that financial market disruptions may negatively affect the availability of credit to small businesses.  At this time, it is not likely that the market performance will have “a large direct effect on small business lending.”  Survey data suggests that, overall, the market for small business credit has tightened.

Other data related to business lending with smaller banks seems encouraging.  Mishkin stated, “such loans have continued to expand at a fairly robust pace through mid-October.”  Larger banks, since they are more directly impacted by loan securitization markets, would be much morel likely to experience problems in lending ability.  The direct effect on small business owners would be fairly limited.

One additional aspect that the Governor did mention was the fact that many small businesses use personal real estate assets to secure their loans.  It is no secret that the struggling market has taken a toll on property values.  This direct connection to what is currently the weakest investment market is a cause for concern that business owners should consider.

Governor Mishkin stresses that, “at least for now, the effects have generally been quite limited.”  There is continued uncertainty with this situation, as with our economic outlook as a whole.  The Federal Reserve is, as usual, keeping a close eye for problems that could arise.

At the latest Federal Open Market Committee meeting, last Wednesday, there was another rate cut.  The target for the federal funds rate was reduced by 25 basis points to 4 ½ percent.

This action is supposed to “forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.”

According to the press release, the FOMC predicts that “after this action, the upside risks to inflation roughly balance the downside risks to growth.”  It is believed that this additional rate cut action will help to curtail the effects of inflation on the economy.  There has been some upward pressure on inflation due to energy and commodity prices, but core inflation readings for this year have improved modestly.

With all the concern for inflation, the continued weakening of the dollar, and the sub-prime lender’s market hanging on by a thread, there is just no telling which way the economy is going to go.  When the rates were cut in September, it was implied that we were on the verge of a recession.  The markets improved for a while, but everything else seemed to stay nearly the same. Should we think that the rate cut is a sign that the economy is more on a downward slant than the Fed cares to mention?

The Fed, consumers, investors and economists alike are unsure about how the economy is going to perform.  Things could go either way at this point.  It seems that with all of the inflation concerns that further rate cuts won’t be happening for a while.  Once again, only time will tell how the economy will do.

In addition to the reduction in the Federal funds rate, the FOMC injected a dramatic $41 billion into the banking system one day later.  This is the highest infusion of liquidity since September of 2001.  Other added funds were inserted into the financial system at amounts of $38 billion in August and September.  This liquidity assistance is primarily to help keep lenders in business.  Without the additional cash flow, there could be a major freeze on credit in the nation.  The system runs on a complicated system of debt, so a credit crunch would be very bad news.  How much more money will it take to keep a credit crunch from happening?

Economic uncertainty will most likely continue to be the repeated term that describes the outlook for the United States economy.  Hopefully, we will pull through.