Have the rate hikes worked? Not yet, say observers

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Did the
Federal Reserve Board‘s interest rate hikes last year slow the economy? The answer, from both sides of the Hudson River, is a resounding “No,” and that’s why the Feb. 2 announcement that rates are headed even higher came as little surprise.

Both Frank Meyers, a homebuilder in Wyckoff, N.J., and Jim O’Sullivan, an economist in New York, say the Fed failed to accomplish much of anything by raising rates three times in 1999. Consumers still spent at a blistering pace during the holiday season. Manufacturers still churned out products. Commodity dealers still charged more for everything from oil to lumber.

As a result, the
Federal Open Market Committee said Wednesday afternoon that it was raising the two rates it controls directly. The group nudged the federal funds rate to 5.75 percent from 5.5 percent, while also increasing the discount rate to 5.25 percent from 5.0 percent.

“For me, I kind of keep watch on this stuff and truthfully I have not seen the slowdown,” says Meyers, the 55-year-old owner of Prestige Developers Inc. “As long as the income level stays, people get raises, people have their jobs and you don’t hear hysteria in the news, people kind of just think, ‘We’ll make more money next year and I can pay the mortgage.’ “

With regard to the Fed and its interest rate moves, he adds, “There is a nonchalance.”

“I just don’t see over the period that that has made my job any more difficult,” Meyers says. “It hasn’t diminished my sales.”

That sanguine attitude helps explain why Wall Street professionals saw today’s rate move coming. Deep in the heart of Wall Street,
J.P. Morgan & Co.
U.S. economist O’Sullivan sums up the view of many of his colleagues rather succinctly:

“Overall financial conditions probably haven’t tightened that much.”

He points out that in the face of a funds rate that rose to 5.5 percent from 4.75 percent, unemployment fell throughout last year and the stock market soared. That gave people the ability to demand higher wages and the means to buy more goods and services, even if they had to pay $5 more a month on their home equity lines of credit.

So what happens next? Probably more Fed-inspired pain. Consider that the combination of higher energy and labor costs has forced companies from Continental Airlines Inc. and FedEx Corp. to McDonald’s Corp. to either raise prices recently or say that they were considering doing so. That means inflation, which largely had been confined to the energy sector of the economy, is starting to spill over into other areas measured by the core Consumer Price Index, which excludes food and oil costs.

“When you look at the leading indicators, it would suggest that the trend is about to turn,” O’Sullivan says. “The odds are that the core CPI does start to drift up a bit and that puts more pressure on the Fed to tighten.”

Not that a few hikes concern Meyers all that much. In his conversations with lenders, real estate agents and the like, he’s found that most don’t expect mortgage or other rates to get much higher than they already are. That would keep consumers from getting pinched too badly.

At the same time, part of him wonders about the health of today’s economy — particularly the housing market. As a builder for almost three decades, he’s seeing lenders ease their underwriting standards in the face of rising rates today the same way they did before previous market crashes in the early- and mid-1980s. Back then, many borrowers who took the bait slipped into default because they found themselves with too much debt and too little income once the economy slowed.

“There are parallels and no, it is not a different time,” he says. “The example I often cite is when I watch the lenders be aggressive with lending money.”

“The lenders, mortgage brokers and, back in the ’70s the savings banks, just seemed to loosen up, saying ‘We expect you’re going to make more money’ or ‘We’ll lend you more because you’re going to get a good bonus,’ ” he adds. “But all of a sudden incomes go backward or stay static, or then all of a sudden the taxes go up or it’s an ARM and then the rates go up. People can’t afford to pay their mortgages and then the foreclosure rate goes up, and that’s what gets the snowball rolling down the hill.”