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Commentary: Even "Free Money" May Not Do the Trick


When Federal Reserve Chairman Alan Greenspan gathers his colleagues in the central bank's stately boardroom on Oct. 2, there's no doubt about what they'll do: cut interest rates. The widely expected cut would be the second in two weeks and would lower short-term rates below 3% for the first time since the 1960s. Even more important, it would cut real rates, after adjusting for inflation, to zero. In the world of economics, that's equivalent to free money.

Normally, that sort of financial firepower would be more than enough to repel a recession. But these are not normal times. The Sept. 11 attacks have shaken America's psyche, making the future a lot more uncertain than it was just a few weeks ago. That has led to a fundamental reassessment of risk throughout society. You can see it in half-empty airplanes and the plunge in consumer confidence. But it has also shown up in the financial markets, where stocks have slumped and corporate-bond yields have risen despite the Fed's Sept. 17 rate cut. The financial and emotional fallout from Terror Tuesday will continue to stymie Greenspan's efforts--and rates may go even lower still.

STOCK HIT. For starters, the swoon in stocks has tightened financial conditions considerably since early September, according to a Goldman, Sachs & Co. index. Roughly $1 trillion worth of wealth has been destroyed by the collapse of the stock market in the wake of the terrorist strikes. That has torn a big hole in investors' pockets and more than offset the stimulus from the Fed. Although stocks bounced up briefly after a week of steep losses, financial conditions are not likely to change much soon.

Despite the Fed's offer of free money, the steep slide on Wall Street has also put the kibosh on initial public offerings--a market that was already reeling from the nosedive of the Nasdaq. Six companies were forced to scrap or postpone IPOs after the terrorist attacks, including Continental Airlines' (CAI.A) planned spin-off of Continental Express.

Financing has also gotten tougher in the $1.8 trillion corporate-bond market. After soaring earlier in September, debt issuance by Corporate America has slowed to a trickle. Deutsche Bank Securities Inc. strategist Louise Purtle thinks U.S. companies will end up issuing some $30 billion in bonds in September, vs. $80 billion in May. "One of the big problems in our economy is a lack of access to capital," says Keith E. Busse, CEO of Steel Dynamics Inc. (STLD) in Fort Wayne, Ind. "I don't think bringing interest rates down is going to have a large effect."

BUDGET BUST? Moreover, while the Fed has cut its own rates, fear of falling profits and financial distress has sent long-term corporate-bond yields up rather than down. Only the bluest of blue chips have been spared. The fallout has been most severe in the junk-bond market, where yields have risen nearly two percentage points. Bond yields are also being pushed up by other worries: possible forced selling by insurers to cover claims stemming from the crisis and chatter in Washington of a budget-busting fiscal package. Greenspan has already cautioned lawmakers against overdoing it, but Congress may not be in a mood to heed the Fed chief.

Instead, lawmakers are listening to their constituents--and what they're hearing isn't good. Consumer confidence suffered its worst drop since 1990 in September, hit by rising unemployment, falling stock prices, and the terrorist attacks. "I don't care how low interest rates go," says David A. Wyss of Standard & Poor's Corp., a unit of The McGraw-Hill Companies. "If people are scared, they won't buy." That's one more reason why this time, free money may not be enough. By Rich Miller and Laura Cohn

Miller and Cohn cover the Fed from Washington.


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