The Federal Reserve Bank had to do something quickly and dramatically to dampen the downward spiral of confidence and spending, similar to late 2008, which began earlier this year and threatened to become much more serious earlier this month, says Jim Haughey, chief economist for Reed Construction Data, Norcross, Ga. "This was the only option available," writes Haughey. "Already, it is clear that the expected impact is occurring, although we do not yet know if the impact is big enough to restart the economic recovery. The FRB has two mandates: maintain both price stability and low unemployment. The recent announcement is driven by the unemployment rate mandate and creates added risk of future inflation. The economy is awash in liquidity in order to finance anything that quickly creates jobs and provides income to those without jobs or with reduced incomes.
"The headlines will focus on cheap credit with the central bank’s lending rate to member banks held at near 0.0% through mid-2013. But it is not the low interest rates that will prompt added borrowing and spending. It is the enhanced access to credit that has the positive short term spending impact as happened in the last few years. With this comes higher spending confidence which provides the added demand for building space and facility capacity necessary to sustain the construction recovery.
"The housing market will feel the first and biggest impact from the extension of the cheap credit policy. Mortgage rates will be marginally lower although this may be masked for several months by the flight from a suddenly weaker Euro. More importantly, cancelling the plan to reduce liquidity in the economy will prompt lenders to loosen credit approval standards. Some behind the scenes arm twisting from Washington will also contribute to easier credit standards.
"Credit cost and access are not key market drivers for either the heavy construction or institutional building markets. The extension of cheap credit will have negligible direct impact in these markets, although there will be a positive spillover from more taxes collected in a stronger economy.
"The same spillover from a stronger economy will have a quicker and bigger impact on spending by private non-residential developers. Already, projected net operating return projections have improved for projects in planning. Keep this in perspective. The improvement is from the last few weeks and returns expected profits to where they were a few months ago. This market has been inching higher for most of the year. The extension of cheap credit substantially removes the risk of expected profit markdowns in a 1% growth economy.
"While the FRB action takes much of the sting out of the US Government rating downgrade and the turnabout of congressional debate from boosting to cutting spending, it contributes nothing to solving the spending/deficit problem. Instead, it will add to these problems if the maintenance of high liquidity is used to make more bad loans (remember subprime mortgages), spent on public programs that do not enhance private sector productivity (remember the stimulus plan only postponed the layoff of several hundred thousand state and local government employees) or borrowed and spent by consumers creating loans that they can not service when interest rates are higher."