US Central Bank Gave Investors Early Comfort
Unlike two years ago, fast assurances helped markets to stabilize without tons of quick cash
MARKET investors knew over the weekend that Federal Reserve Board chairman Alan Greenspan would open up the government's purse to any floundering Wall Street firms. Fed officials had so indicated. When the stock market plunged in October 1987, the Federal Reserve Board waited until after the debacle before making it clear it would be the lender of last resort.
What a difference two years make. Instead of continuing on a dizzy dip downward, the stock markets stabilized early this week - without a lot of actual cash from the nation's central banker. Only takeover stocks were tippy.
``Basically, what the Fed did was commendable,'' says Alan Meltzer, a frequent critic of the central bank and an economist at Carnegie Mellon University.
The Fed provided the comfort that it would not allow the financial system to unravel. During the market plunge of fall 1987, several Wall Street firms had trouble obtaining credit immediately after the crash. And during the great crash of 1929, many banks and brokerage houses withered because they were unable to obtain capital.
This past weekend, however, top officials were determined not to let that happen. Top administration official as well as Mr. Greenspan called Wall Street leaders to assure them funds would be forthcoming as needed. At the same time, Federal Reserve Board officials contacted other central bankers to be sure there was no misunderstanding about the bank's intentions. Lyle Gramley, a former Fed governor, says the central bank brought in its staff on Sunday to watch trading on overseas markets.
Then, on Monday, the Fed actually injected a small amount of funds into the financial world, resulting in interest rates being nudged downward slightly. But as Paul Kasriel, a former Fed economist now at Northern Trust Company, quips, ``It's more of an open-mouth policy than an open-market policy.'' [Small investors are still shy, Page 9.]
In some ways the Fed had little choice - because of inflation. Last Friday the government reported Producer Prices surged 0.9 percent and retail sales rose 0.5 percent. Tomorrow, the government will report the September Consumer Price Index. ``It's likely to be a difficult number for the government,'' says Brian Fabbri, chief economist for Midland Montagu, an investment bank.
Few economists expect the Fed to change its policies anytime soon. Mr. Meltzer of Carnegie Mellon says it would be a mistake for the Fed to begin easing too quickly. ``We have to get inflation down to zero without too much pain,'' he says.
Traders generally believe this is Greenspan's plan. ``I don't think the Fed is kidding about inflation,'' says Patrick Parcells, a trader and vice president at Credit Commercial de France.
However, Martin Feldstein, a former chairman of the Council of Economic Advisers (CEA), says the Fed should begin to ease rates now. ``Prior to the stock market crash my view was that there was a case for some small Fed easing to offset the effects of a very high dollar - not to drive the dollar down as such but to balance the fact the dollar is so strong we are likely to have weak maybe even negative exports,'' says Mr. Feldstein, a professor at Harvard University.
The Federal Reserve Board got a better idea of the impact of the stronger dollar on the trade deficit yesterday when the government reported the August merchandise trade numbers. Shearson Lehman Hutton Inc. had estimated this deficit swelled to $9 billion, up from $7.6 billion in July.
A generally weaker economy may give the Fed leeway to relax rates. Although few economists expect a full-blown recession anytime soon, most agree that the industrial sector - especially the auto industry - is pinched. ``If you loosen interest rates now, I doubt the economy will take off like a rocket,'' says Mr. Gramley, now the chief economist at the Mortgage Bankers Association in Washington.
Michael Boskin, CEA's current chairman, says the administration expects only 2 percent real economic growth over the next few quarters. ``We expect a rebound in 1990,'' Mr. Boskin said on Monday at a conference. In contrast, the economy was actually too wound up in the fall of 1987.
For the economy to rebound now, it will need more money. The growth rate of the monetary base - the nation's cash, checking and savings accounts - so far this year is about 3 percent. This would be the low side of the Fed's target of 3 to 5 percent annual growth. The White House has already expressed its frustration with the Fed.
There were, however, no critics of the Fed's actions on Monday when it faced a stock market strained by the drop of 190.58 points on the previous Friday. At about 11:40 a.m. on Monday the Fed injected a small amount of reserves into the marketplace. The Fed did this by purchasing government securities from member banks. The Fed then gave the banks a credit which can be used to satisfy reserve requirements. ``It was a message - the Fed was just saying, `we're here,''' says Fabbri.