Video: No Slum Dunk rate cut in sight?

updated 9/5/2007 5:33:54 PM ET 2007-09-05T21:33:54

A painful credit crunch is taking its worst toll on the already ailing housing market, while its impact on the rest of the economy so far seems limited, the Federal Reserve reported Wednesday.

Both Wall Street and Main Street have anxiously awaited the Fed’s survey of business conditions for clues about what the central bank will do regarding interest rates on Sept. 18, its next regularly scheduled meeting.

Economists increasingly believe the Fed at that meeting will lower a key interest rate, now at 5.25 percent, by at least one-quarter percentage point to protect the economy from the credit crisis. The Fed has not lowered this rate in four years.

“Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited,” the Fed’s report said.

On Wall Street, stocks tumbled as the Fed’s report disappointed investors who were looking for a guarantee that rates will go down this month. The Dow Jones industrial average closed down 143.39 points.

The report failed to “make a clear case for the Fed to ease,” said T.J. Marta, fixed income strategist at RBC Capital Markets.

Credit problems began with “subprime” mortgages held by people with spotty credit histories or low incomes. The problems have spread to some more creditworthy borrowers and intensified in August, unnerving Wall Street. In reaction, the Fed has pumped tens of billions of dollars into the financial system and lowered an interest rate that it charges banks for loans.

Fed Chairman Ben Bernanke, in a speech last Friday, pledged that the central bank would “act as needed” to limit any fallout on the economy from the credit crunch. He made clear, though, that the Fed would be driven by what is best for the economy and would not bail out investors and lenders.

In Wednesday’s survey, the Fed said most banks reported that the recent developments in financial markets had led to more restrictive lending standards for people wanting to obtain home mortgages. That “was having a noticeable effect on housing activity,” the Fed said. “The reduction in credit availability added to uncertainty about when the housing market might turn around.”

The Fed said several banks noted that commercial real estate markets had experienced “somewhat tighter credit conditions.” But some banks said “credit availability and credit quality remained good for most consumer and business borrowers.”

Credit is the economy’s life blood. If it becomes more difficult to obtain, people and companies might spend and invest less.

Major Market Indices

In the Fed’s report, retail sales generally were positive. But several Fed regions described automobile and furniture sales as slow. Similarly, manufacturing expanded across most regions, although there were reports of “softening demand for building materials and autos.”

The survey is based on information that the Fed’s 12 regional banks collected before Aug. 27.

Bernanke, in last week’s speech, said the Fed would pay close attention to the “timeliest indicators” as well as information gleaned from businesses and banks. Economic data taken before the credit markets tightened up in August will be much less useful to policymakers to assess the country’s economic health, he said.

On the jobs front, the Fed said nearly every district reported at least modest increases in employment. The lone exception was the Chicago region, which characterized employment conditions as mixed.

With regard to inflation, outside a burst of higher food costs, most districts reported little change in overall price pressures. A subdued inflation climate would give the Fed more leeway to cut rates if it needs to.

The housing slump, the biggest drag on the economy, worsened.

“The weakness in the housing market deepened across most districts, with sales weak or declining and prices reported to be falling or flat,” the Fed said.

After a five-year boom, the housing market went bust last year. Higher interest rates and weaker home values clobbered homeowners, especially higher-risk subprime borrowers with adjustable-rate mortgages. Foreclosures and late payments have soared. Lenders have been forced out of business and hedge funds and other investors in mortgage securities have taken a big financial hit.

Against this backdrop, the economy, which grew at a brisk 4 percent pace in the April-to-June period, is expected to slow to half that pace in the three months from July through September.

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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