Those Tumbling Rates

Recession brings a sudden drop in the high cost of borrowing money

With dramatic suddenness, America's interest-rate fever broke last week. The bench-mark prime rate, the interest that banks charge their best corporate customers, dropped from 20% only four weeks ago to 17%. The popular $10,000 six-month money-market certificates, which carried Golcondan interest payoffs of 15.7% only six weeks ago, were offering a mere 9.5%. Even mortgage rates took a tumble. California's Home Savings & Loan, the nation's largest thrift institution, dropped its home lending rate from 17.5% to 12.75%. Said Irwin Kellner, chief economist at New York's Manufacturers Hanover Trust: "Rates are following a financial version of Newton's law that for every action there is an opposite and equal reaction."

Though interest-rate temperatures were going down, the U.S. economy remained in intensive care. Inflation psychology, which had long led consumers to buy just about anything at any price because of fears that costs would keep rising, seems to have lost its grip. A public increasingly concerned about job security has begun to pull back at the check-out counter. Installment debt rose by only $1.4 billion in March, a 38% drop from the February rate; the consumer confidence index of the Conference Board, a Manhattan-based business study group, reached its lowest level since the 1974-75 recession.

There was a little good news on the inflation front last week. While wholesale prices rose 1.4% in March, they went up only .5% in April, the lowest monthly increase since May 1979. This should result in lower prices for consumers later in the year. But the nation's trade deficit hit a record $12.2 billion during the first quarter of 1980, largely because of higher-priced petroleum and metals imports. Lower American interest rates and a higher trade deficit pushed the dollar, which had shown surprising strength on international money markets until the past month, back down toward its anemic rates of last summer.

Some financial experts attributed the precipitous decline in interest rates to the Federal Reserve's apparent decision to ease its draconian policy of monetary restraint now that the recession appears to be taking hold. When the nation's money supply declined at an annual rate of 1.6% or $6.2 billion to $382.9 billion in the past three months instead of rising 5% as originally targeted by the Fed, economists thought the central bank might be ready to turn on the money tap once again. This seemed to be confirmed when the Federal Reserve announced that it was dismantling some of the credit control apparatus it had built in March. At that time, the Federal Reserve began charging major banks a three-point interest-rate surcharge on funds they borrowed from it; that levy was eliminated last week. There were also strong expectations that Washington might be preparing to discard the rest of the credit curbs initiated two months ago. Fed Chairman Paul Volcker had been opposed to the measures, which included reserve requirements on new credit-card borrowings and on money-market funds. Observers expected that Volcker would use the first available opportunity, like the recession, to get rid of the limitations.

The nation's central bank denies that it is changing its policy course. It insists that the unprecedented free fall in interest rates is the predictable result of its success in getting a better grip on the money supply. Last fall, when Volcker switched tactics in the attack on inflation and decided to concentrate on controlling the growth of the money supply rather than the level of interest rates, he warned that the rates would rise sharply but then also fall rapidly. With less money available to meet loan demand, rates at first rise. But when credit demand falls off because loans have become so expensive, rates drop.

The declines were seen as confirmation of that prediction. Insisted one Federal Reserve governor last week: "Our strategy for fighting inflation is agreed on completely. We are focusing on money supply as the best way to combine growth with reduced inflation over the long haul. If that means broader swings in interest rates in the short run, so be it."

Interest rates are expected to sink still further, with the prime rate at perhaps 10% to 12% by year's end. This is due largely to the weakening economy. Alan Greenspan, former chief economist for President Ford, observes: "The U.S. has moved rapidly into a severe recession. The hopes that it would be mild and of short duration appear to be precisely that--hopes."

Gloomy businessmen are now bracing for an economic downturn as deep as any in the postwar period. They consequently see no need to borrow funds at the still relatively high rates so as to expand capacity or hire new workers. General Electric Chairman Reginald Jones predicts that the prime rate will sink to 12% or 13% before investment picks up. Explains Gilbert Heebner, chief economist at the Philadelphia National Bank: "It was like 20% was some magic threshold. Borrowers simply stopped borrowing. Even small independent businessmen like farmers chose to liquidate their crops rather than borrow money."

A number of savvy corporate treasurers anticipated the Fed's March credit restraints by borrowing heavily in January and February, thus stockpiling enough cash to see them safely through cold economic times. As a result, bank commercial and industrial loans, after going up at an annual rate of 27.6% in January and 26.8% in February, rose a scant .3% in March and then plunged 7.4% in April.

Bankers believe it will also take further drops in interest rates before consumers start taking out more loans. Says Robert W. Renner, chairman of the Citizens State Bank in Hartford City (pop. 8,000), Ind.: "I really think we're going to have to get down to the 12% to 13% range before the typical consumer comes back to see us." The Citizens State Bank last week made only one auto loan at 17.5% interest. A year ago, it was making twelve to 14 such loans a week at 12.5%.

Similarly, consumers are shying away from the mortgage market regardless of lower lending costs.

Jack Carlson, chief economist of the National Association of Realtors, says that the largest group of borrowers deserted the home-buying market when rates went above 14% and will not return until interest goes back below that level. Currently, mortgage money costs approximately 15% across the country.

Despite last week's slide in the cost of money, the Federal Reserve will remain under heavy pressure to stimulate the economy by returning to an easy money policy. As concern with growing unemployment (current rate: 7%) begins to replace the country's obsession with inflation, the Fed will need all its vaunted independence to resist political pressure. Says Du Pont Chairman Irving Shapiro: "Volcker's program is successful. The risk now is that politicians will do damn fool things to win an election rather than solve the inflation. If that occurs, the whole recession process will have been a waste." Returning too quickly to a stimulative money policy would only assure that the next round of inflation will be even higher than the current level, a disastrous 18%. One measure of how exploding expenses are affecting Americans: maintaining a moderate standard of living for a typical family of four in New York City now costs a cool $23,000-plus a year.

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