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To: Lee who wrote (73272)	10/21/1998 11:25:00 PM
From: Mohan Marette	Read Replies (1) \| Respond to of 176387

Is Greenspan & Co playing catch up? What happened to pre-emptive strikes. Hi Lee: It is as if this article is tailor-made just for you.<vbg> Appreciate any thoughts or comments but if you are in a silly mood you can try a bit of sarcasm I wouldn't mind.<g> ============================ Bridge News Report COMMENTARY: GREENSPAN'S FED KEEPS PLAYING CATCH-UP ALEXANDRIA, Va.--The Federal Open Market Committee's recent panicky quarter-point cuts in the federal funds rate target clearly indicate that Federal Reserve Chairman Al Greenspan has blown it, on two counts. First, the Fed (and many sycophantic fed watchers) has been much slower than financial markets in recognizing that a potential slowdown in the economy, due largely to events outside the U.S. economy, dictates lower short-term interest rates. Second, by suddenly trying to play catch-up with the drop in short-term Treasury bill yields, the Fed has dramatically revealed that it does not in fact control short-term interest rates, except the rather insignificant federal funds rate (the rate at which banks lend to each other on an overnight basis). CONCERNS ABOUT a slowing economy have grown steadily since the Asian economic crisis erupted 15 months ago. Those concerns, coupled with a steadily declining inflation rate, call for lower interest rates. Longer-term interest rates have been declining over the last 18 months to reflect both lower inflation and, more recently, fears of an economic slowdown. Although the Treasury yield curve has been declining, the yield spread for several types of private-sector debt, notably junk bonds, has been rising since the Russian domestic debt default on Aug. 17 and, more recently, the Long-Term Capital Management debacle. Hence, instead of declining, as they should, so as to stimulate economic activity, many longer-term rates have been increasing in recent weeks, raising the specter of a credit crunch at the cusp of an economic downturn. In effect, the financial markets are all screwed up today, in large part because the markets continue to err in following St. Alan's inept signaling in setting short-term rates, such as the prime rate that banks charge. THE FEDERAL Open Market Committee, under Greenspan's leadership, has followed the markets in recent weeks rather than leading them in setting short-term rates. From last spring through August, the end-of-day yield on the three-month Treasury bill was usually less than 50 basis points (half a percent) below the federal funds rate target. Only once between Apr. 1 and Aug. 26 did this difference breach 50 basis points, reaching 51 basis points on Aug. 7, even as yields on longer-term Treasuries were reaching historical lows. Since Aug. 27, and despite two cuts in the rate target, the yield differential between the three-month bill and the rate target has never been less than 50 basis points. This yield differential reached 100 basis points before the first cut in the rate target. Within two days after that cut, the differential went above 100 basis points, where it is today despite last week's second cut in the rate target. CLEARLY, the Federal Open Market Committee, or Greenspan acting on his own, has to cut the rate target further to catch up with the dictates of the financial markets. Talk about playing "follow the leader." Because banks arbitrarily float the prime rate at three percentage points above the rate target, the prime is dropping as the rate target is cut, which leads to lower interest rates for those borrowers whose loan rates are tied to the prime. Therefore, slowness in cutting the rate target keeps the prime rate too high too long. ======================== Courtesy of all these good people. By Bert Ely of Ely & Co. Bert Ely of Ely & Co. is a Washington banking-industry consultant. Ely's views do not necessarily reflect those of Bridge News or Business Week Online.