The Fed Takes Subprime Woes in Stride

http://www.businessweek.com/bwdaily/dnflash/content/jun2007/db20070627_650894.htm?chan=top+news_top+news+index_top+story Fed will leave the Fed rate intact at 5.25% Putting the Majority First By cutting short-term rates now, the Fed would run the risk of causing the financial markets to get frothy and the real economy to overheat. When the economy grows too quickly, demand exceeds supply and inflation sets in. That's intolerable to the Fed, whose main job is to keep the economy growing at a healthy pace with minimal inflation. Put it this way: The U.S. has a population of a little over 300 million. By comparison, there are a little under 10 million outstanding subprime loans, of which a little over 20% are delinquent or foreclosed on. Assuming typical household sizes, that's around 5.4 million people affected, calculates analyst Michael Youngblood of FBR Investment Management. By leaving interest rates where they are, the Fed is implicitly putting the interests of the majority ahead of the interests of the minority. Ironically, the best hope for subprime borrowers would be for the troubles in the subprime world to spread to the rest of the economy. A problem that became widespread and systemic would most likely jolt the Fed into cutting rates, helping relieve the pressure on subprime borrowers as well as on the rest of the economy. So far, though, there has been relatively little contagion from the subprime mess. On the whole, though, the U.S. economy seems to be rebounding from a weak first quarter, when growth was below a 1% annual rate. Action Economics is looking for gross domestic product in the June quarter, which is just ending, to rebound to a healthy 3.5% annual rate. Are people cutting back on borrowing—a classic sign of a credit crunch? Companies certainly aren't. Rotenberg and Yechiely note that corporate borrowing "has reached levels not seen since the late 1990s." Numbers that look frightening on the individual level seem less significant in the context of a U.S. economy that generates $10 trillion in personal income annually, which is what the Fed keeps its eye on. In a June 27 note, economist Edward Yardeni of Yardeni Research said that even if you buy Bank of America's (BAC) forecast that $500 billion worth of adjustable-rate mortgages are scheduled to reset this year by an average of 2 percentage points, that comes to only an extra $10 billion to $15 billion in interest payments. That's a tenth or so of 1% of total personal income. Yardeni's reaction was to quote the title of a classic Peggy Lee song: "Is that all there is?"