The Blog

Obama and the Fed

12:00 PM, Aug 15, 2009 • By IRWIN M. STELZER
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Trouble ahead.

Almost exactly two years ago economists discovered that the problems in the housing and mortgage markets had spread to the financial sector. Subprime mortgages proved highly infectious, a couple of Bear Stearns funds collapsed, banks suddenly looked at their neighbors with such suspicion that they refused to lend to them, and economists dusted off their copies of histories of the Great Depression, looking for a guide to the future.

One year later they returned those books to the shelves as the "real economy" seemed to prove itself resistant to the diseases afflicting those greedy, over-bonused bankers. But summer's lease on a recovery proved all too short, and in a few months there was a run on the essays of one Ben Bernanke, in an effort to learn what the Federal Reserve Board chairman had in mind to stop the rush to economic collapse. We discovered that he was indeed in the great tradition of Walter Bagehot, who wisely advised in 1873 that "whatever bank or banks keep the ultimate banking reserve of the country must lend that reserve more freely in time of apprehension." The Fed not only pumped money into a frozen credit system to thaw it out, but joined the federal government in inventing new ways to cope with what was clearly a panic.

And now, two years after subprime mortgages became the domino that toppled or almost toppled many institutions, one year after the mother of all recessions scared consumers into zipping their wallets, corporate executives into cutting investment and letting inventories run down, it is glad, confident morning again in America.

Of 47 economists responding to a survey by the Wall Street Journal, 27 say the recession has ended, and 11 say the trough has been reached or will be by next month. They expect the economy to grow at an annual rate of 2.4 percent in the current quarter, and many are looking forward to a 2.75 percent to 3 percent growth rate by year end. The housing market is showing signs of life. Toll Brothers, one of the nation's largest builders of up-scale homes, reports that lower prices, reasonable mortgage rates, a rebounding stock market and special incentives have combined to produce an increase in orders, and D.R. Horton, the country's largest builder, reports a 22 percent rise in sales from the past quarter.

Still, the housing industry has a long way to go before it returns to health. Even with the recent improvement, Robert Toll, the company's CEO says "Traffic still stinks" -- a statement of such blinding concision and clarity as to put economists to shame. Repossessed homes continue to flood and depress the market; high unemployment has consumers wary of taking on new commitments; and about one-quarter of all homes are now worth less than the mortgages owed on them.

The real question now is not only when will house prices and new construction show real zip, but when will consumers feel confident enough to start spending, and when the draw-down of inventories will leave retailers' shelves so bare that they have to place significant new orders.

Bernanke and his Fed colleagues pored over these tea leaves last week and decided that economic activity is "leveling out" but that the economy "is likely to remain weak for some time." Which calls for the sort of measured response by the central bank that has won Bernanke the plaudits of economists and demands from a vast majority of them that he be reappointed when his term as chairman ends on January 31 of next year, perhaps derailing Obama's plan to name his economic adviser, former Harvard president Larry Summers to that post.

In recognition of the headwinds the economy still faces, the Fed will continue its program of buying as much as $1.25 trillion in agency mortgage-backed securities so as to keep mortgage rates from rising. It will also keep its near-zero target for short-term interest rates for the foreseeable future. But in recognition of the improvement in the economy the Fed will complete its $300 billion program of purchases of Treasury IOUs in October -- it has already bought some $240 billion. That might push long-term interest rates up, making it more expensive for businessmen to invest, and more costly for consumers to take their already-decreasingly deployed credit cards out of their purses and wallets, perhaps aborting the recovery. The rise in interest rates would, under those circumstances, undoubtedly be accompanied by a rise in the presidential blood pressure.