Interest Rate Cuts Won’t Spark a Lasting Rally

Lower interest rates may be beneficial for the stock market in the near term. But stocks won’t rally substantially until the financial markets are convinced that lower rates are putting some pep back into the U.S. economy. And that could take many months.

Everyone on Wall Street last week was anticipating interest rate cuts by the Federal Reserve Board. Stock prices rose as a result.

But the experts agree that although share prices might climb a tad more in the weeks ahead as rate cuts are announced, it is much too early to expect that a bull market will result from easing of monetary policy by the Fed.

Larry Wachtel, the stock market analyst at Prudential-Bache Securities, says that unless the Fed cuts rates by a surprisingly large amount in the next few weeks “everyone’s eyes will glaze over and they’ll go back to sleep.”

And even if the Fed reduces rates more than expected (perhaps by an aggressive move such as a reduction in its discount rate), the stock market will view the move skeptically until it sees signs that banks are beginning to lend money once again and corporations and consumers are willing to borrow.

The big fear on Wall Street is that the Fed might be “pushing on a string”--which is another way of saying that you can lead a borrower to lower interest rates but you can’t make him borrow.

L. Crandall Hays, director of investments at Robert Baird & Co. in Milwaukee, says the stock market will soon come to an equilibrium point between those worried about the economy and those happy about lower interest rates. At that point, the stock market will decline if it looks like the recession will be deep or rise if lower borrowing costs are stimulating growth.

“At some point, you look beyond the recession. But first you have to know how deep and how long (the recession) will be,” Hays says.

There are, of course, other factors that must be included in any analysis of the stock market.

Although Wall Street tended to ignore the Middle East situation last week, what happens in Kuwait is vital to the stock market and interest rates.

If the Middle East problem is resolved quickly and without causing inflation to rise, the world will have an opportunity to lower interest rates. War in the Middle East, on the other hand, could aggravate inflation and sidetrack cuts in interest rates.

Another important factor is the health of the nation’s banking system. The failure of even one money center bank could negate any positive effect of lower interest rates.

William Raftery, vice president of technical research at Smith Barney & Co., says his firm recommended early last week that clients increase their exposure to stocks by a small amount. But he’s not expecting equity prices to rise sharply just yet, even if interest rates retreat. “We don’t see a major turnaround for the market for a while,” Raftery says.

The vast majority of Wall Streeters are assuming, of course, that the Fed can reduce interest rates any time it wants. But a small group of investment pros is worried that this might not be the case in 1990.

This group is concerned that if the Fed tries to reduce rates by a significant amount, it will cause the dollar to collapse and intensify the exodus of foreign investors from U.S. markets. Then interest rates would have to be raised to recoup foreign investment.

The higher interest rates that would ultimately occur under this dire scenario could also result in sharply lower stock prices.

We Could Sell Alaska to Get Rid of Deficit

Stop whining, America! Sure the economy stinks. And the smell could get worse if big banks start failing, if large numbers of homeowners begin defaulting on their mortgages or if the Fed is unable to lower interest rates by a significant amount.

But there are solutions to even this mess. We could, for instance, sell Alaska. Selling assets is popular with everyone who took on too much debt in the 1980s, and this country certainly qualifies for that club.

Canada or the Soviet Union would probably pay enough for Alaska to solve the federal budget deficit many times over. Or we could rent out the Grand Canyon every other weekend, turn the Statue of Liberty into a catering hall or auction the contents of the Smithsonian.

And war is usually good for the economy, although admittedly not much fun for the folks who have to fight it.

Consumers and corporations in this country have gotten incredibly pessimistic in the past few months. And although the depth of their despair may be justified after the high experienced during the spend-now-pay-later decade, the situation isn’t hopeless. There are, the real experts say, solutions to our dilemma--and we get to keep Alaska.

Here are some diverse suggestions from the experts, although they don’t necessarily work in combination:

* “We were premature in getting rid of the special incentives to save,” says Larry Kimbell, senior economist with the WEFA Group in Bala-Cynwyd, Pa. He thinks that America should not only return to a savings plan similar to the originally conceived individual retirement accounts but also strengthen the proposal.

Kimbell believes that Americans should be permitted to deposit an unlimited amount in an IRA-like vehicle. The money should be taxed only after it is withdrawn.

But Kimbell also proposes that people be permitted to withdraw money from this savings account before retirement--say, when they want to buy a home. This will make the savings plan attractive to younger people.

“We could double or triple personal savings,” says Kimbell. And some of that money, of course, would be invested in U.S. government securities, thus reducing this nation’s reliance on foreign investment.

* Edward Yardeni, the chief economist at Prudential-Bache Securities, believes that the country can recover from its economic problems the old-fashioned way: through lower interest rates.

“Easier monetary policy; it has always worked in the past to get us out of problems like this. I think it will work again,” says Yardeni, who’s predicting the Fed will reduce interest rates any minute and follow through with a discount rate cut by Christmas.

“I think they will save the day,” Yardeni says. He believes that the dollar has already fallen in anticipation of lower U.S. rates. And even if the currency declines some more and foreign investors continue to flee the United States, “so what,” he says. The cheaper dollar will stimulate exports and reduce spending on imports.

Yardeni says the United States won’t know if lower rates will stimulate lending until it tries. So start bringing rates down.

* Paul Samuelson, Nobelist in economics, believes that Fed Chairman Alan Greenspan should not only attempt to bring down the level of short-term interest rates but should also tackle the problem of high long-term interest rates.

Short-term rates are easy to control. But rates on bonds with longer maturities tend to be controlled by the level of rates worldwide. And long-term rates are also more important when trying to stimulate the economy.

Samuelson says the Fed--as it did in 1982--should directly intervene in the long-term bond market by buying these securities. And it shouldn’t do so secretly. It should let the world know that it is trying to bring down long-term rates.

Samuelson says that when Paul A. Volcker, the previous Federal Reserve chairman, took this tactic in 1982 he “leaked to the market what he was doing.” The central bank, in short, should “indicate to the people in the market (the Fed) has an interest in getting rates down.”

* “In the short run we should go ahead and have a pretty severe recession,” says Norman Bailey, a private consultant and former chief economist for the National Security Council during Ronald Reagan’s first administration.

Bailey isn’t suggesting that the United States purposely cause economic pain. He simply believes that the Fed should not bail out the banking system and overextended Americans by dropping interest rates too much.

After the recession, Bailey says, the United States will have erased a lot of the bad corporate and personal debt, and the United States can move forward into one of its strongest periods of growth ever. “It’s painful to cut out a cancer,” says Bailey. “But it’s a whole lot more painful to leave it in.”

* Ravi Batra, author of the controversial 1987 best seller “The Great Depression of 1990,” believes that one new tax will do the trick. “A wealth tax,” says Batra, of 5% on Americans with assets of $2 million or more could raise $150 billion a year and sharply reduce the federal budget deficit.

Although raising taxes during a recession is generally a bad idea because it cuts consumer spending, this wealth tax wouldn’t have the same impact on the rich.

Batra, an economics professor at Southern Methodist University in Dallas, would also raise the nation’s minimum wage to $6 an hour. He says the increase would get workers off the welfare rolls and shift the burden of supporting them from government to private industry.

A Hot Time Ahead for Investment Bankers

As if the investment banking community doesn’t have enough problems, experts say the number of liability cases is rising against the guys and gals who brought the world all those mergers in the 1980s.

Experts say they expect the heat to be turned up under investment bankers as more of the takeovers fashioned during the past decade encounter trouble.

That bit of news may cheer up any worker who lost his job as the result of the takeover tidal wave of the 1980s. But on Wall Street, where investment bankers are quickly becoming lepers, liability claims could be the final disaster.

Arthur Aufses, a partner with the New York law firm Kramer, Levin, Nessen, Kamin & Frankel, says some investment bankers simply goofed when calculating the tax and accounting consequences of a transaction.

“Typical areas of investment banker failure include erroneous mathematical calculations in arriving at conclusions and undue reliance on representations made by management and others,” Aufses says.

Aufses, an expert on the subject, says only one case so far has resulted in damages against an investment banking firm. But he adds that “the number of cases against investment bankers is increasing and the courts seem receptive to them.”

Directors in the past have been very vulnerable to suits from shareholders, and this has resulted in a sharp increase in insurance costs. Investment bankers aren’t taking out insurance, but many are requiring the companies they work for to agree to indemnify them against claims.

Some other problems: Investment bankers also sometimes overvalue a company because they fail to recognize how important one person is to the business. But Aufses says he is not aware of any case of purposeful misconduct or criminal behavior.

“Financial advisers are going to find themselves under attack in connection with any failed financial institution,” Aufses says.

Questions have already been asked in court about the performance of investment bankers working on the takeovers of Metromedia, Meyers Parking, Nationwide Corp., Nutri/System, RJR Nabisco and others, Aufses says.

The purchase of a 200,000-share block of Lockheed stock right at the close of trading on Monday has raised some regulators’ eyebrows. The block was bought at $30.25 a share. Little more than an hour later, Harold Simmons’ NL Industries made a proposal to acquire Lockheed. The stock opened at $32.375 on Tuesday. The regulators are curious about the coincidence . . . Towers & Perrin, a management consulting firm, says that despite the slowing economy, companies say they will give executives average merit pay increases of 5% next year. Only 10% of the 102 companies surveyed planned to cut increases.