Volcker's Pinch Begins

Soaring interest buoys the buck but starts a slide in housing

When he boldly 'tackled the twin problems of runaway inflation at home and a hemorrhaging dollar abroad by tightening credit and raising interest rates a month ago, Federal Reserve Chairman Paul Volcker was almost universally hailed. The road down from 13% inflation would be long and difficult, but it was also imperative; and Volcker's policy was acclaimed as necessary. Now the costs of the descent are beginning to become evident.

Since the Federal Reserve action, the prime interest rate paid by top corporations has jumped another 2% beyond its previously record heights to reach 15 1/2%, and bankers believe that it may go still higher. Interest rates on Government bonds have leaped above levels prevailing at the outbreak of the Civil War, when Confederate forces were encamped at Manassas, ready to march on Washington. The Dow Jones index of industrial stocks since early October has slumped nearly 100 points and closed last week at 806.

The Fed's draconian measures have first hit the housing industry. Last week the National Association of Home Builders called an emergency meeting in Washington to bewail the high mortgage rates. The group's economist, Michael Sumichrast, darkly predicted that housing starts, which ran at a 1.9 million annual rate in September, will soon be cut in half. The soaring cost of money, he claimed, has already forced 10 million Americans to abandon temporarily plans for that dream house.

The first signs of a housing decline are evident around the country. Average mortgage rates have jumped over two points since January of 1978 to 11.2%, and in California, Colorado, Indiana and other places they are 13% or 14%. Monthly payments are often no longer listed in the handy books real estate agents carry, and salesmen have been forced to use hand-held calculators to compute the numbing bill. Residential loans in Washington, D.C., have virtually halted. In the

Los Angeles area, where home prices formerly rose fast and frequently, sellers have been forced to reduce $140,000 bungalows to $120,000. In Chicago, sales in new home projects are down 68% since January.

Worse than the high interest rates is the sheer shortage of mortgage money. Usury laws in two dozen states limit interest rates to below 13%. Thus many banks and savings institutions have stopped making loans because it is impossible for them to earn any profit. Traditional lenders are also running short of cash because people are transferring funds from savings accounts to booming money market funds, which invest money in high-yielding securities and pay twice as much as passbook accounts. Perhaps three-quarters of the savings and loan associations in Chicago have stopped making mortgage deals.

Signs of recession are also multiplying.

Big Three auto sales last month were down a jarring 23% from a year ago, and the industry has laid off 93,600 of its 765,400 hourly workers. Executive recruiters are receiving considerably fewer requests to find and hire managers.

Despite the distress, Volcker's interest rate policy continues to win support from bankers, businessmen and politicians. The U.S. League of Savings Associations unanimously approved the Fed's actions, and the group's chief economist, Ken Thygerson, admits that it "was necessary to deal a lethal blow to speculation in the housing market." Ben Heineman, president of Northwest Industries, calls the program a "sensible way of checking inflation." Even Senate Banking Chairman William Proxmire, normally the central bank's most vociferous critic, endorses the program, saying it has had an important "psychological effect." The battle against inflation finally seems serious.

Volcker's policy continues to earn raves abroad. The dollar's decline, which had precipitated the action, has been at least temporarily checked. Despite nervousness in world financial markets caused by events in Iran, the dollar has been strong for the past month. Typically, one Frankfurt banker says with a sigh of relief: "For the first time I can confidently see a stable rate for the dollar." Silver, platinum and copper markets, which had soared like comets in early October, have returned to some calm.

But as Volckerism continues to drive up the cost of money and tighten credit much further, the cheering will increasingly be mixed with catcalls. House Majority Leader Jim Wright of Texas is already bitterly denouncing the Federal Reserve for "pouring gasoline on a fire in a misguided effort to put it out." He argues that high interest itself is a cause of inflation because it increases the cost of buying a new home or constructing a new plant. Builders Union President Robert Georgine warned that President Carter's pledge to his workers to "not fight inflation with your jobs" would be recalled, perhaps vengefully, by blue-collar voters in next year's primaries. Carter's chief economic adviser Charles Schueltze and Treasury Secretary G. William Miller began privately hinting that they had worries about the intensity of the Volcker program, and former Fed Chairman Miller made a gratuitous dig at his successor: "Had I stayed at the Fed, my timing would have been different."

Breaking the inflationary psychology after 15 years of ever higher prices will be a titanic task. The American consumer has developed the attitude of "buy now before it's higher," as new figures showed again last week. Consumer installment debt exploded by a record $4.5 billion during September to a total of $303.9 billion. The lemming-like rush of consumers into debt could force the Federal Reserve to push interest rates still higher or perhaps to begin limiting the amount of credit available.

The inflation outlook offers no reason for the Fed to pull back. Last week Carter's anti-inflation czar, Alfred Kahn, admitted that his earlier hopes for the nation to be out of double-digit inflation by next spring have been eliminated by increases in oil prices and mortgage rates. Kahn argued that inflation will not be brought under control so long as OPEC continues raising the cost of crude and the U.S. remains dependent on foreign oil. As a means of lessening that reliance, he said, the Administration had been considering a 500 per gal. gasoline tax and even gasoline rationing.

The nation's inflation, deeply ingrained and long neglected, cannot be fought by money policy alone, though that is a necessary ingredient. Tough fiscal and energy policies are also necessary. In sum, the nation needs a combination of taut reins on credit, restrained federal spending and increased freedom from Middle East oil. Nothing short of all three can end years of price explosions and energy profligacy, which are threatening the structure of American society. Author Theodore White has called inflation "the hidden threat disorganized government always holds over those who try to plan, to save, to be prudent." Volcker's painful policy is an attempt to remove that threat.

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