- The Washington Times - Thursday, September 22, 2005

Disasters always have some economic effect that may or may not influence lending rates. Hurricane Katrina and the September 11 attacks — two of the nation’s most recent and most profound catastrophic events — are no different.

After the September 11 attacks, the Federal Reserve Board made it clear that it would use whatever powers necessary to assuage its economic damage. In fact, the Fed reduced short-term interest rates four times in the three months after the attacks, cutting the federal funds rate in half, from 3.50 percent to 1.75 percent.

The moves helped spur a sharp drop in mortgage rates, creating a housing and refinancing boom. The effects of these are felt to this day.

After Katrina hit, the Fed has remained silent, even though the potential detrimental economic side effects of Katrina could be far worse than September 11.

Why?

After some research, I now understand why the Fed has not jumped to lower rates in the Katrina’s aftermath. Let’s compare the two events.

When the terrorists attacked, the U.S. economy was already close to recession levels. Annualized growth in the third quarter of 2001 was less than 1.5 percent. This compares to a healthy 3.5 percent level in 2005.

Healthy growth numbers might be good for wages and employment, but they can also bring about inflation, and Fed Chairman Alan Greenspan is not about to lower rates if it will risk inflation.

But what about the job loss created by Katrina? The forecast is currently running in the 400,000 range. Surely such a hit in the job market won’t overheat the economy.

Some experts say otherwise. The high unemployment level is likely to be short-lived, as there is an enormous amount of cleanup and rebuilding to do. Jobs soon will be created.

Other analysts explain the Fed’s response, or lack of response, to Katrina on the type of catastrophe the storm wrought.

When the jets hit the Twin Towers, the jobs lost were largely transactional and could easily be recovered. Banks and other transactional institutions could carry on their business from another office building.

But Katrina’s wrath hit what are sometimes called the “hard” assets of America.

Nine of the region’s oil refineries are inoperable, resulting in skyrocketing energy prices. Agricultural production will slow considerably, causing a supply shortage, without an offsetting drop in demand. Remember one of the rules of economics: Low supply coupled with high demand equals rising prices.

There’s also the issue of supply lines. Katrina has affected the supply chain necessary to deliver goods from suppliers to consumers, exacerbating the shortage.

All this leads to one thing: Inflation.

As I said, Mr. Greenspan is not about to lower interest rates at a time when inflation could be just around the corner.

On the other hand, if the economic damage from Hurricane Katrina proves to be a longer-term problem, which is entirely possible, the Fed may certainly reverse its current policy of raising interest rates and begin to lower them.

Meanwhile, don’t expect a sharp decline in mortgage rates anytime soon.

Henry Savage is president of PMC mortgage in Alexandria. Reach him by e-mail at [email protected]

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