Cut Is Good News in Golden State

Despite some disappointment in the Federal Reserve Board’s modest interest rate cut Tuesday, California stands to benefit roundly from the central bank’s shift in course if, as expected, it leads to further rate reductions in the coming months.

The Fed move comes at a time when California’s economy, although clearly stronger than the nation’s, has shown increasing signs of softening. Exports are down, job growth has slowed sharply in the Bay Area, and confidence among consumers and businesses throughout the state is slipping for the first time since the recovery began in earnest in 1995.

While the Fed’s target was global in nature, California figures to get a relatively bigger boost, particularly in two critical areas. As economists see it, the Fed’s move is likely to keep California’s interest-sensitive housing industry humming longer and enhance the chances that the state’s vital exports sector will recover more quickly from Asia’s dampening effects.

The expected rate cut did not significantly change economists’ outlook for California, but it did shore up confidence among analysts and executives who had turned increasingly pessimistic as the global financial crisis widened to Russia and Latin America.

“Now that we’ve heard from [Fed Chairman] Alan Greenspan, I think the danger of a near-term, Asia-contagion recession is fading,” said Ted Gibson, chief economist at the California Department of Finance.

The primary impact on California from the Fed move, while not big, is likely to come in the housing industry, which has become even more important to the state as manufacturing and tourism have weakened in the face of the Asian crisis.

Like other short- and long-term rates, home loan rates had already dropped to unusually low levels in recent weeks, partly in anticipation of the Fed action. So there is little expectation that 30-year, fixed mortgage rates, for example, will immediately fall that much lower than the latest average of 6.64%, said economist G.U. Krueger of the California Assn. of Realtors.

But Krueger said additional Fed cuts would make mortgages even cheaper, and analysts widely believe the Fed’s first step Tuesday will, at the very least, help push up sales, add fuel to the refinancing market and boost new home building, which is badly lagging demand.

“I think it will prolong the run,” said Randall Lewis of Upland-based Lewis Homes, referring to California’s real estate recovery, which is fresher and more vigorous than the nation’s. Although the interest rate cut will probably lower his cost of borrowing, Lewis said he isn’t changing his business plan or his cautious land buying. But industrywide, he said, it may indeed spur additional building.

Manufacturers were more likely to express disappointment in the size of the Fed’s action, which lowered the federal funds rate--the rate banks charge each other for overnight loans--by a quarter of a percentage point (or 25 basis points), to 5.25%.

“I hoped the cut would be 50 basis points,” said Greg Mariscal, export manager at Hirsch Pipe & Supply Co. in Van Nuys, whose exports of construction supplies have fallen 25% in the current third quarter from a year earlier.

Nevertheless, Mariscal is encouraged by the Fed move, which in the short term should reduce his company’s interest payments on a line of credit tied to the prime rate.

Like other exporters, Mariscal’s hope is that the Fed’s initiative will ease the global credit crunch and soften the dollar, which would boost economic activity abroad and lift demand for U.S. goods.

“Every day I get faxes that say: ‘Your prices are too high. Can you please give us more discounts?’ It kills me,” Mariscal said.

Few states have as much at stake in exports--to Asia in particular--as California. Shipments to Asia account for half the state’s merchandise exports--double the nationwide percentage. But already, troubles in Asia resulted in a 6% drop in California’s exports in the second quarter, the first such decline since the early 1990s, and expectations for the second half of the year are more grim.

Most of that decline has been borne by high-tech makers in the Silicon Valley, where the job growth rate has plunged from nearly 6% at the start of the year to less than half that. In recent months, California’s high-tech companies have announced more than 7,500 layoffs, and industry giants such as Hewlett-Packard and Intel have put some capital expansions on hold.

Richard O’Brien, Hewlett-Packard’s top economist, said people in Silicon Valley are not jumping up and down at the Fed’s announcement. “Oh, yes, it’s heartening,” he said. “But a quarter of a percent[age point] isn’t going to have a major impact.” He added, however, that he expects further cuts that could have deeper, widespread effects.

Ross DeVol, director of regional studies at the Milken Institute, an economic think tank in Santa Monica, said a rate cut of even half a percentage point would not have been enough to cause companies to buy more capital goods. But DeVol said the rate cut could have an immeasurable psychological effect in calming jittery global markets. Should that happen, he said, it could curb the financial crisis from spreading to Mexico--California’s No. 2 export market--and restore confidence in Asia.

“If we can stabilize Asia faster and begin to see some recovery by mid-next year, Asia’s demand will recover and exports will come back sooner, helping our economy grow by the second half of ‘99,” he said.

A more immediate benefit from the Fed’s move could come if consumers feel more confident about the future and spend more. While retail sales in the first half of this year appeared to be running slightly ahead of last year’s 6% increase, recent surveys of purchasing managers, small businesses and consumers in California all have shown some erosion of confidence.

John Campbell, chief executive of Campbell Automotive Group, which operates four car dealerships in Orange County, said sales this year have been disappointing, given the strong economy. Campbell said he hoped the Fed action would boost confidence. More immediately, he expects it will save him a few thousand dollars a month in interest expenses for maintaining his inventory of Saturns and Saabs--money he said he would divert to marketing and other areas.

“Oh, yeah, I’ll take it,” he said of the rate cut. “That’s for sure.”

* LIMITED IMPACT

Consumer rates had already fallen ahead of Fed easing. A1

* MARKET REACTS

Stocks were mixed as some investors hoped for a deeper cut. D4

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The Fed in the ‘90s

The Federal Reserve Board cut its key short-term interest rate, the federal funds rate, to 5.25% on Tuesday from 5.5%--the first cut since January 1996. The Fed slashed rates in the early 1990s to pull the U.S. economy out of recession. It then boosted rates sharply in 1994 to keep the economy from expanding too quickly. The fed funds rate since 1990:

Tuesday: 5.25%

What The Rate Cut Means

* The federal funds rate is the overnight loan rate among banks, which the Fed can influence by tightening or loosening monetary policy. As banks’ key short-term rate, it affects the other rates banks pay for money and charge for loans.

* While the Fed can control short-term interest rates, it does not directly control long-term rates, which are determined by market forces. For example, mortgage rates have already plunged in recent weeks as long-term Treasury bond yields have tumbled, partly because investors have sought “safe haven” investments.

* Yields on short-term Treasury securities also have tumbled in recent weeks--signaling that investors expect a series of Fed rate cuts in coming months.

Source: Federal Reserve Board