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Rx for the ‘R’ Word? : Another Fed drop in rates might thaw banks

The recession that is about to grip the U.S. economy has set off an unusual and disturbing phenomenon of deflation which is pushing down prices, particularly in the real estate market. Falling prices in normal times would be a boon to consumers, but now they are creating new uncertainties in an economy already overloaded in debt and weakened by widespread layoffs, loan delinquencies and a credit crunch.

Extraordinary times require some extraordinary measures--and courage. The Federal Reserve Board should consider cutting interest rates again to stimulate the economy. “The appropriate response to weakness in the economy is a more stimulative monetary policy,” said Rep. Lee Hamilton of Indiana, the Democratic chairman of the Joint Economic Committee of Congress.

True, the Fed has cut the federal funds rate that banks charge each other on overnight loans four times since July. It recently even cut the discount rate it charges on loans to banks for the first time since 1986.

But banks generally have failed to cut their interest rates because of a squeeze on their profits caused by problem real estate loans. Declining commercial real estate prices are throwing borrowers into default, putting pressure on beleaguered banks, which are reluctant to resume lending. Exacerbating all this is the prospect of war in the Mideast. If fighting breaks out, bankers and businesses expect slow payments and rising loan defaults.

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The Fed’s traditional concern when it comes to firing up the economy is that reducing interest rates will fuel inflation. But the annual inflation rate, excluding energy, rose only 3.9% in November. What’s happening is a round of deflation with the prices declining for major assets such as real estate. There’s downward pressure on prices of commodities and consumer goods, too.

If debt levels were not so high, both business and consumers could take the hit. But that’s not the case, so lower prices could mean less profits for employers. That in turn could lead to more layoffs. Consumers will have less to spend. The result: A worsening and prolonged recession.

If the Fed drops interest rates (and banks follow suit this time around), it would mean lower home-loan rates--and anyone with a variable mortgage rate can appreciate what a savings that might mean.

A recent drop in home-loan rates helped sales of existing single family homes to rise 3% in November, reversing two months of steep declines, according to the National Assn. of Realtors. That’s not enough to mark a turnaround in housing, but it’s an encouraging sign that the slump in housing may have have hit bottom.

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That’s welcome news--but a recovery in housing and elsewhere will depend on affordable interest rates.

The R word--though recession has never been acknowledged by President Bush--has cast a pall over Americans who already are worried about the grim prospect of war. It’s time for the Fed to step in with an encouraging move: another interest-rate cut.


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