Gross: Cutting Interest Rates Won’t Stop the Bleeding

In the past week a strange group has been pleading for the Federal Reserve to return the punch bowl to the toga party—to slash interest rates and restart the Wall Street revelry. The Punch Bowl Caucus, whose members hail from all over and hold different ideological views, share a common belief: that the Federal Reserve, by reducing either or both of the interest rates it controls, can turn the clock back to the halcyon days of 2005 and 2006, when home values moved in only one direction, when defaults were nonexistent, and when credit to homebuyers, consumers, and, above all, to hedge fund operators, ran downhill like a mighty stream.

CNBC commentator James Cramer founded the caucus with his now-famous capitalist manifesto on August 3. (He serves as honorary chairman of the Wall Street chapter.) Cramer urged the Fed to act on behalf of the greatest among us—"My people [that is, hedge fund operators, private equiteers, and assorted tycoons] have been in this game for 25 years. And they are losing their jobs and these firms are going to go out of business"—as well as the least among us. "Fourteen million people took a mortgage in the last three years. Seven million of them took teaser rates or took piggyback rates. They will lose their homes."

While Cramer's tirade was lighting up YouTube, desperate manufacturers banded together to form a Midwestern chapter. Ford CEO Alan Mulally and Chrysler CEO Robert Nardelli may be new to Detroit, but they've quickly adopted the local custom of looking to Washington when sales begin to slump. A week after signing on to Chrysler, Nardelli, the former CEO of Home Depot, realized he had jumped from one position where he got nailed by the declining housing market to another where he's likely to get nailed by the declining housing market. (Falling housing prices and less-forgiving credit markets are making more Americans think twice about tapping home equity to finance $30,000 car purchases.) So on August 16 Nardelli suggested it would be a good idea if the Fed were to cut rates. The following week Mulally obliquely echoed Nardelli's call.

Meanwhile, supply-siders were organizing their own punch bowl chapter, which has a unique bylaw: The government should never intervene in the economy, unless it is to bail out hedge funds and investment banks. Trusting the suddenly volatile, forward-looking markets more than backward-looking government data, supply-siders have concluded that inflation is under control, and hence that it is safe for banks to start giving money away again. Wayne Angell, a former governor of the Federal Reserve, convened this chapter in its clubhouse—the Wall Street Journal op-ed page—with a call (subscription required) for the Fed to cut the Federal funds target rate by 75 basis points. Angell's motion was heartily seconded by CNBC's Larry Kudlow, writing in the National Review group blog the Corner.

The caucus has had its biggest recruiting successes in the housing sector. In announcing the formation of this chapter, Angelo Mozilo, CEO of Countrywide Financial, the nation's largest mortgage lender, succumbed to the common sin of extrapolating to the general from one's particular circumstances. In his interview with CNBC’s Maria Bartiromo, Mozilo said that the punk housing market would undoubtedly lead the nation into recession—an event that should inspire cuts in the Fed funds rate.

But it's not just struggling rich guys who are begging for cuts. Late last week Martin Wolf, chief economics commentator of the Financial Times, formed an international auxiliary. Wolf appealed (subscription required) to Americans' vanity and missionary zeal. He pleaded with Bernanke to forget about the sufferings of gazillionaires like Angelo Mozilo and think about poor Chinese peasants. In today's global economy, he argued, Americans excel at borrowing and spending while the rest of the world excels at saving. For years, "the U.S. has been the world's spender and borrower of last resort." Americans must spend to keep the world's factories humming. And to do so, they need cheap credit.

The Punch Bowl Caucus has already proved to be an effective lobbyist. The Federal Open Market Committee meets next on September 18, and the futures markets indicate that investors believe a rate cut is highly likely: a 49-percent chance of a 25-basis-point reduction and a 51-percent chance of a 50-basis-point reduction, based on Friday's closing prices, according to Citigroup. But while the caucus looks as though it will chalk up an early tactical victory, I wonder whether it has a winning strategy. The Punch Bowl Caucus holds as an organizing principle that the Federal Reserve can provide a real and psychological boost to markets—and hence minimize or obviate entirely the fallout of natural economic occurrences such as asset bubbles and the business cycle. College students don't alleviate the aftereffects of an evening spent at the punch bowl by returning to lap up the dregs. Just so, finance types should know that cheap money, endless leverage, and credit on demand aren't the cure for a hangover caused by too much cheap money, leverage, and credit on demand.

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