How Bond Traders Hold Us Back

All year we've been hearing about how aggressively almighty Alan Greenspan is cutting interest rates. Just hold on, the logic goes. Soon big-ticket items that folks often finance, from refrigerators to cars, will be so affordable that we won't be able to resist digging deeper into debt to spend. That will lift the economy, end a blistering surge in layoffs, pick up corporate profits, ignite the stock market and restore trillions of dollars of lost wealth.

It is a magic formula, and it has worked in the past. There is just one catch: the interest rates that really matter would have to decline for this formula to succeed. And as anyone looking for a mortgage will tell you, that hasn't happened. We're talking about two rates here. The first is the Treasury's 10-year bond, which is the instrument that dictates mortgage rates. Even after a tumble last week, the yield on the T bond was at 4.99%, vs. 4.91% at the start of the year; 30-year fixed-rate mortgages average 7.16%, higher than in March and down just a bit from 7.3% in January, rate-tracker HSH reports. Is this any way to revive an economy?

Don't blame the Federal Reserve. Chairman Greenspan has done his part by cutting short-term rates deeper and faster than at any time since the 1990-91 recession. When the Fed meets Aug. 21, he is likely to drop the benchmark Fed Funds target rate again--to 3.5% from the current 3.75%. That rate was at 6.5% on Jan. 1.

But Greenspan doesn't dictate long-term rates. So while his efforts have shaved a percentage point or so off the cost of auto loans and credit cards, they have done nothing to ease the burden of fixed-rate mortgages, the mother of all household debt. Even though housing sales have otherwise been a bright spot, stubbornly high mortgage rates put off many buyers and preclude millions from refinancing, which could save them hundreds each month. If you think a one-time tax rebate of $300 is tonic for an ailing economy, just think about what a monthly mortgage rebate would do.

Blame this predicament on Wall Street's bond traders, a hopelessly sullen bunch bent on blocking a recovery. They are the ones keeping long-term rates high. The traders, not Greenspan, set rates by bidding bond prices up and down on the open market, moving yields in synch with their world view. That view for much of this year has been that things aren't getting any worse. See what I mean by hopeless? Last week, outplacement firm Challenger Gray & Christmas reported that layoffs announced in July hit an eight-year high. Retail sales are falling off a cliff. Not getting worse? Bond traders just don't get it. Maybe we should muzzle them and let Greenspan set long rates too.

If the maestro could, he probably would nudge long rates lower, though not by a lot. Long rates are where the leverage is. Cut them too much, and you risk putting so much buying power in people's hands that inflation kicks up disastrously. Which is why it is best to leave long rates in the hands of the market, where a collective judgment is better than any one person's.