Fed Trims Key Rate to Zero

WASHINGTON, DC-These are trying economic times in a modern economic environment, so it is little surprise that the Federal Reserve Bank has taken unprecedented steps in trying to curb calamity. The Fed decided to down-size the Federal Funds Rate from an already low 1% to between 0.25% to zero.

The industry had been expecting a modest 25 or even 50 basis points trimmed away from this key rate. Fed officials, including Fed chairman Ben Bernanke had been sending out mixed signals of late over their intentions–promising on one hand to use all tools available, and then noting on the other that the Federal Funds interest rate was dropping too low to be an effective recessionary-fighting instrument.

Clearly, though, the “use all tools” school-of-thought won out with Tuesday’s decision by the Federal Open Market Committee. Not only was the decision to cut the rate to this level unanimous but FOMC all but said it would keep rates at this level for as long as necessary. We anticipate “that weak economic conditions are likely to warrant [an] exceptionally low level of the federal funds rate for some time,” it said in a prepared statement. Furthermore, it added, the Federal Reserve will continue to consider ways of using its balance sheet to support credit markets and economic activity.

Given that the Fed has already been fighting this recession very aggressively, it is difficult to imagine what else it could do. It could focus more on quantitative easing, Peter Cohan, principal with Peter Cohan & Assoc., tells GlobeSt.com. “Basically that means, [the Fed] next try to set longer term interest rates– the federal funds rate is short term. To do this they would essentially flood the markets with longer term money.”

Like the cuts to the Federal Funds rate, though, Cohan says this would be pointless. “The Federal Funds rate, after all, was hovering around 5% some 18 months ago. It has been steadily dropping to zero, to little effect in the economy.”

Indeed, the commercial real estate industry has met each interest rate cut with a collective shrug. The cuts have done little to affect and industry which has been grappling with a credit crunch for the last 18 months. This time, though, might be different. Zero percent is essentially free money, and that is bound to have an impact in the lending market.

It may well be that with money this cheap lenders will finally be inspired to begin lending again. “A downward movement in the Fed Funds rate is meant to induce more ‘risk-taking’ on the part of the lenders, because the returns on other assets become more attractive relative to a risk-free return,” Villanova School of Business professor Scott Dressler, tells GlobeSt.com. With “the Fed funds rate rendered impotent–near zero–look for the Fed to attempt to induce more ‘risk-taking’ on the part of the lenders using less traditional means.” An example of this would be to pursue ‘open-market operations’ in more long-term Treasury bill markets, he adds.

One tweak the Fed may try, advises James Clark, managing principal of EnTrust Realty Advisors, of the Alter Group: Broadening the scope of businesses that may borrow from the Fed may have the most significant impact. “Perhaps a little competition will encourage banks to start lending again,” he tells GlobeSt.com.

Clearly something must happen for lending to jumpstart. The $250-billion infusion of capital into the banking system earlier this year did not inspire banks to spread the wealth.

“We have one client right now with good credit,” David Weisman, a commercial Real Estate attorney at Greenspoon Marder, tells GlobeSt.com. “and the best he can find is from a smaller, ‘maverick’ lender who will give him 7.5% to 8%, regardless of how low prime is.”