Alan Greenspan and the Open Market Committee of the Federal Reserve have received a lot of press coverage recently for their aggressive attempts to revive the economy and ward off a recession. Their unprecedented program of mostly half-point cuts has reduced the discount rate (the rate certain banks pay to borrow funds from the Federal Reserve to meet their daily capital requirements) from six to 3.25 percent since the beginning of this year. Most banks have followed suit by lowering their prime lending rate (the rate these banks supposedly charge their very best customers) from 9.5 to 6.75 percent over the same period.
Have these downward trends been reflected in the mortgage market? Not really. That probably sounds strange in light of all of the downward pressure being applied by Greenspan & Co. However, today’s mortgage lenders use Treasury rates as their guide, not the discount rate or prime rate, to price their loans. Interest rates on new loans are based on the Treasury market, either directly through an index-plus-spread formula, or indirectly through an internal cost-of-funds calculation. However, regardless of how they price their loans, most mortgage lenders are influenced more by the market’s opinion of what the Fed should have done than by what the Fed actually did.
An inevitable effect of the Fed’s changes will be an eventual drop in the cost of borrowing. Unfortunately, very few sectors of the economy are growing fast enough to need or want new debt. Instead, many companies are downsizing their staffs, cutting expenses, eliminating lower-margin products, and struggling to pay down the large loans they accumulated during the "irrational exuberance" of the 1990s boom. The contraction in business activity appears to be widespread, leading some economists to suggest that the U.S. economy already has slumped into recession, and that Alan Greenspan should reduce rates further to limit the severity of the downturn. If evidence grows that these market-watchers are correct, additional Fed stimulus becomes more likely.
However, other economists point to rising oil prices, the California energy crisis, a tight labor market, maxed-out industrial capacity, and stubbornly-high consumer confidence as support for their argument that the economy still has "legs" and that inflation is just around the corner. Those who subscribe to this scenario suggest that the Fed already has done too much and, therefore, should increase rates to avoid the looming inflationary spiral.