While the Federal Reserve Bank loosened credit strings by reducing a key interest rate last week to stimulate the national economy, the effect may be a bit like pushing on a string, said several local analysts and bankers.
“I don’t think they could have done more as far as cutting the interest rate (by a half-percent, bringing the total of three cuts since the beginning of the year to 1.5 percent),” said Alan Gin, a University of San Diego economics professor. “It may be a bit like pushing on a string. The hope is the rate cuts will spur businesses to borrow more money and consumers to buy more. Sometimes it works, and sometimes it doesn’t.”
The immediate impact of the Fed’s decrease of the federal funds rate from 5.5 percent to 5 percent was for most banks to cut their prime rate to 8 percent. The prime rate, the interest rate banks charge their best customers, is a key index and the basis for many short-term business and consumer loans.
The effect of the Fed’s rate cut will be to reduce borrowing costs for many businesses with short-term loans tied to the prime rate, said Robert Sarver, president of San Diego-based California Bank and Trust.
“This is going to help companies, especially those with financial problems, because the cost of their borrowing has been reduced,” Sarver said. “But borrowers are still a little cautious right now, and many are waiting to see if things are going to bottom out.”
Yet the bottom, as far as the stock market is concerned, was difficult to discern last week as investors, hoping for a rate cut of three-quarters of a point, continued a sell-off that has been going on for more than a year.
In reaction to the Fed’s decrease March 20, the Dow Jones industrial average dropped 238 points or 2.4 percent to 9,720, its lowest level since March 1999. The Nasdaq index fell nearly 94 points, or 4.8 percent to 1,857, its worst finish since October 1998.
The markets rallied briefly at midweek but by March 22, the sell-off continued with the Dow ending down 98 points, off its previous-day close to 9,389, suggesting the market was punishing the blue chips as well as the tech-heavy Nasdaq index. The Nasdaq had shown a 3.7 percent gain for the day.
“We’re certainly not in a free fall, but most people will now call this a bear market,” said Howard Roth, an economist with Freeman Associates Investment Management in Rancho Santa Fe. “Wall Street wanted more, but it’s not the Fed’s job to prop up stock prices.”
Roth said the reduced interest rates might stimulate increased borrowing, but lenders may still be cautious to extend more credit based on a growing national trend in increased defaulting, or problem loans.
Ron Carlson, conversion vice chairman for U.S. Bank in San Diego, said he hasn’t seen any rise in bad loans at his bank. U.S. Bank, formerly called Scripps Bank, was purchased by Minneapolis-based U.S. Bancorp last year.
At the end of December, the problem loan portfolio was well below a half-percent, Carlson said. The local economy doesn’t appear to be heading into a recession and is much better off than the last time the area slid into a prolonged slump, Carlson said.
“We don’t have any kind of the problems like we had in the early 1990s when many banks had a serious deterioration of their credits,” he said.
Yet the timing for a downturn may mirror what occurred a decade ago.
“It may be a situation where San Diego is the last in and the last out and if there is a short (national economic) decline, we may be in and out before San Diego is significantly impacted.”
What concerns most observers is California’s escalating energy crisis, which reared its ugly head last week in the form of two days of rolling blackouts in San Diego.
“The big problem we’re facing in San Diego and the rest of the state is the electric situation, which has caused energy prices to soar,” USD’s Gin said. “While (the interest rate cuts) will help, they may not be near enough to counteract the higher prices they are spending for energy bills.”
The massive hit the stock market has taken over the past year has affected many local consumers who have seen the value of their retirement nest eggs decline, causing many to think twice before buying big-ticket items such as cars and appliances, Gin said.
“People are less prone to make big commitments or take out large amounts of debt if they are worried about their future,” he said.
Gin wasn’t sure where the stock market would bottom out, but said the restructuring provided investors with good buying opportunities. He said he purchased shares in Qualcomm Inc. when it hit $48 earlier this month. About a year ago, the stock was trading close to $200.
The national economy may very well be in the middle of a recession, using the definition of two successive quarters of declining growth, Gin said. The first two quarters may show a decline in the gross domestic product, followed by a rebound in the second half, which will be led by an upturn in the stock market, Gin said.
Whether the Fed decides to shave another quarter- or half-point off the short-term rate when the Reserve Board meets again in May is still hard to pinpoint, Roth said.
“It all depends on what we see in the economy in reaction to what they’ve done. If we continue to get weak numbers in employment and in GDP growth (a report due next month) we should see more cuts,” he said.
