Fed Bails Out Wall Street at Main Street's Expense

To much of the nation, Federal Reserve Chairman Benjamin Bernanke may seem like he's riding to the economy's rescue, but to a growing number of small business owners, he's a "Wrong Way" Corrigan.

The National Federation of Independent Business (NFIB) certainly subscribes to that view, and has since the Fed first cut interest rates back in September. The move was reportedly designed to bolster the economy, but the nation's largest small business organization doesn't see it that way. "I think [the Fed] is helping 12 big banks. They won't lend to each other unless interest rates go down, which is troublesome because there are more than 12 banks in the U.S.; there are 8,000 of them," said NFIB Chief Economist William Dunkelberg in an exclusive interview.

The group's position is remarkable because the conservative business organization rarely parts ways with the Bush administration on policy matters. Although the Fed is independent, Bernanke, a presidential appointee, reflects the president's thinking on economic policy issues. But the issue goes beyond that. Dunkelberg asserts that Bernanke is actually managing the economy into a recession, both through his comments and through the Fed's rate cuts.

In testimony before the House Budget Committee Thursday (Jan. 17), the Fed chairman painted a decidedly bleak picture of the economy based on a December employment report that he called "disappointing" and a threat to consumer spending. He endorsed a short-term stimulus package as well as further monetary action to avert a recession. The Fed is widely expected to cut the federal funds rate by half a percent later this month. The idea astounds Dunkelberg.

"I don't think cutting the federal funds rate for the whole economy is the answer," he said. "I can tell you that community banks are not looking forward to another 50 basis point cut. They lose a lot of revenue on loans, and they have to reduce savings rates. He's making consumers and savers pay to bail out Wall Street banks. It's painful now as it is, and it doesn't have to be done."

Recent forecasts of recession and low growth emanating out of Washington make it sound like "we are up to our ears in trouble," says the economist. "But if you look at facts and data, there is no credit crunch, at least not from most of America. The housing market is bound up -- nobody in their right mind will finance a spec house -- but most of the housing overbuilding is just in a few places like California, Nevada, Florida, and Arizona."

The picture becomes clearer if you only go back a few months to the third quarter of 2007. Early in November, the Commerce Department reported a 3.9 percent increase in third quarter Gross Domestic Product (GDP), a figure that was later updated to 4.9 percent. Growth couldn't have been much more robust. That month, I raised concerns in my column that economists were forecasting a potential recession in 2008, even though the business climate on Main Street was still strong. I warned at the time that we might be talking ourselves into a recession. See my column Will a Recessionary Mind-Set Sink the Economy?

Now it seems that we are. Dunkelberg believes the problems began with the Fed's first rate cut in September. During the first two weeks of the month, 24 percent of small business owners who responded to the NFIB's monthly survey said they believed the economy was going to get better. As the rolling survey continued, however, the numbers grew increasingly worse. On the day after the announcement, only 17 percent thought the economy would get better, and this fell to 5 percent by the time the survey was finished 12 days later.

To make matters worse, while the Fed's stated policy is to maintain liquidity in the economy, it's having exactly the opposite effect on consumers and small business. Because local banks are now working on tighter margins, they have tightened credit standards, making it harder for consumers and small businesses to borrow money. Mortgage rates, for example, have not fallen in step with the Fed cuts, Dunkelberg notes.

"Main Street banks are not helped; they have more variable-priced loans than variable-priced deposits. Speaking personally as the chairman of a small bank ($100 million in assets), the Fed moves have whacked our profitability," he says.

Like "Wrong Way" Corrigan, Bernanke may ultimately get his desired result, but he's essentially flying east to go west. It's well known that monetary policy is slow acting, and the proposed $100 billion short-term stimulus package is too small to have anything more than a psychological effect. "This is discretionary fiscal policy, which I thought was pretty much discredited," said Dunkelberg.

Indeed, it was. But when the chairman of the Federal Reserve has backed the country into a corner, you go with what you've got. The stock market obviously isn't buying Bernanke's remedy for the economy. It plunged after his remarks. The better solution may be to let Wall Street banks simply write off their losses and get it over with. The real economy, 80 percent of which is made up of small businesses, would certainly be better off.