Can Fed reverse stock market slide, stagnant economy?

McClatchy NewspapersAugust 8, 2011 

WASHINGTON — All eyes will be on the Federal Reserve on Tuesday as it meets to weigh what else it can possibly do to reverse Monday's steep slide in stocks and boost investor sentiment amid fears of Recession 2.0.

Along with central banks in Europe and Asia, the Fed had signaled over the weekend that it would intervene behind the scenes in currency markets if events warranted. But Monday's global rout in financial markets — the worst since the economic crash of 2008 — appears to call for more dramatic action.

"After today, it's a lot harder. They're probably going to feel like they need to do something, but I don't think they feel they've prepared markets to do much more," said Vincent Reinhart, a former top economist at the Fed who's now a scholar at the American Enterprise Institute.

After steep sell-offs in Asia and Europe, the Dow Jones industrial average closed down more than 634.76 points — or 5.6 percent — at 10,809.85. Since July 21, the Dow has plunged 1,915 points, or 15 percent. The S&P 500 shed 79.92 points, almost 6.7 percent, to finish at 1,119.46. The NASDAQ plummeted 174.72 points, or 6.9 percent, to 2357.69.

The dramatic declines, in the wake of Standard & Poor's downgrade of its rating on U.S. credit, heightened pressure on President Barack Obama and politically polarized congressional leaders to take action to prevent a double-dip recession.

Stocks already were tumbling when Obama took to the airwaves Monday afternoon in a bid to calm markets, noting that investors "continue to believe our credit status is AAA."

It was a reference to the fact that investors were piling into Treasury bonds as a haven amid the sell-off. But the president's words — and lack of a new economic fix — appeared only to hasten the downturn. The Dow dived below the psychological threshold of 11,000 as he spoke and closed below that.

The global plunge was triggered not only by the S&P downgrade after markets closed Friday but also by confusing signals from European leaders about addressing their mounting debt crises.

In one bright spot, even if it was also a vote of no confidence in the U.S. economy, crude oil prices on the New York Mercantile Exchange fell $5.57, or 6.4 percent, to settle at $81.31 a barrel for next-month delivery, perhaps giving motorists relief from soaring gas prices. That's a stunning drop of about $17 from the $98 a barrel just a few weeks ago in late July.

The S&P 500 index is about 18 percent off its highs for the year. Most Wall Street analysts consider a 10 percent drop in stock prices a correction, and a 20 percent drop over the period of a few months as the start of a bear market. That's one in which traders expect prices to fall back and negative sentiment persists, keeping stocks falling gradually for months or years.

The market volatility comes amid growing concerns that the U.S. economy might be heading back into recession. Investors have looked past a better-than-expected employment report Friday, strong retail sales numbers for July and a host of indicators of forward momentum. The fear is because year-over-year economic growth is under 2 percent, and when that's happened in the past it's always meant recession.

It's why there's pressure on the Fed to announce something that'd help keep the economy moving forward.

The Fed already has thrown everything but the kitchen sink at the economy since the crisis began in 2008, and with interest rates at zero, it has few tools left in its arsenal.

In June, it ended a controversial program of $600 billion in bond purchases that was designed to force investors to take risks. Called quantitative easing, or QE2, it involved the Fed purchasing bonds to drive down their return to investors, forcing them into riskier bets on stocks and other financial assets.

Any bump that came from that effort has been erased by this year's steep slide in stock prices, and it's unlikely that the Fed will go down that path again. At minimum, the Fed is expected to signal that it will keep the zero interest-rate policy it's had in effect since December 2008 in place for a longer period of time than markets have previously thought.

This move amounts to sweet-talking nervous markets.

A more direct measure, Reinhart said, would be to reduce the interest the Fed pays on the cash banks hold with the Fed, called excess reserves. This would give a disincentive to sit on money and encourage the banks to stay invested in markets and lending to the real economy.

It's unlikely that the Fed will announce a third round of quantitative easing, a QE3, because it doesn't want to be "rushed into large-scale asset purchases," Reinhart said.

The Fed isn't the only one that appears nearly out of ammunition.

The political stalemate in Congress leaves out the chance of any new stimulus spending, and the administration already has tried tax credits for homeowners, car buyers and a cut in payroll taxes. What's left is a question on many minds.

Obama again called on Congress to extend "as soon as possible" the one-year cut in Social Security payroll taxes adopted last December, saving taxpayers as much as $2,136 each this year. He also urged extending unemployment insurance for millions of idled workers to "put money in people's pockets and more customers in stores."

If Congress fails to act, the president said, "it could mean 1 million fewer jobs and half a percent less growth."

House Speaker John Boehner, R-Ohio, repeated his entrenched position, focusing on cutting spending, not increasing it to bolster the economy.

The gulf between the two seemed to underscore how difficult it could be for Congress to agree on another stimulus plan, even despite tepid job-growth numbers that are far below what's needed to make a serious dent in the unemployment rate.

Robert Reich, who served as the labor secretary during the Clinton administration, said there was still time to take a host of additional steps to spur hiring and kick-start the economy.

He urged eliminating payroll taxes on the first $20,000 of income for two years, re-creating the Depression-era Works Projects Administration — which set millions of unemployed Americans to building public works projects — and federal loans to hard-pressed states and local governments.

Reich also urged Congress to grant tax credits to employers that create "net" jobs, to amend laws to allow "distressed homeowners" to declare bankruptcy on their primary residences and to start an infrastructure bank that would borrow from private capital markets in order to finance the construction of roads, bridges and airports.

However, Reich gave no clue how to win approval from the divided Congress for such an ambitious agenda.

Not everyone is panicking.

"The stock market has predicted about twice as many recessions as we've actually had since World War II," said Mark Vitner, managing director and senior economist at the Wells Fargo Economics Group. His firm still forecasts slow but steady growth in the U.S. gross domestic product of about 2.2 percent this year, and no recession.

Vitner also cautioned against knee-jerk stimulus efforts, noting that "temporary tax cuts don't tend to work" in reviving the economy.

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