The Federal Reserve has policies in place that have kept interest rates at near-record low levels, raising questions about what more it can do. Meanwhile, the federal government has not shown the political capacity to enact new stimulus efforts, given the large philosophical divide separating Democrats and Republicans.
“If we tie the hands of fiscal policy, and monetary policy has no new weapons and households are still cutting back . . . that is what the financial markets are reflecting now,” said Dan Seiver, a San Diego State University finance professor.
The debt-limit deal struck by Congress last weekend has been criticized by some budget experts as failing to address the nation’s long-term debt problems even as it staved off a federal default. About $1.1 trillion in stock market wealth has evaporated since the agreement was reached.
Analysts say that if the market losses continue, they will complicate efforts to fix the nation’s ailing housing market and make it more difficult for hard-pressed state and local governments to balance their books. Both of those sectors have been cited as major factors in the nation’s anemic economic growth.
Renewed economic troubles could also reshape the parameters of the high-pitched debate in Washington over the nation’s debt. Some lawmakers may feel less inclined to cut back federal programs during heightened economic trouble. But a decline in tax revenue may force the government to borrow even more money.
“If this economy were a bicycle, it would be about to topple over,” said Jared Bernstein, senior fellow at the Center for Budget and Policy Priorities and formerly the top economic adviser to Vice President Biden. “We need to put pressure on those pedals, but the political system is pushing in the other direction. The economy is crying out for help, and the political system is deaf to those cries.”
When the economy entered crisis in 2008, the government had many weapons in its arsenal to help the housing market. The Treasury Department and Fed started buying mortgage-backed securities, which helped push rates lower for homeowners. The government took over mortgage finance giants Fannie Mae and Freddie Mac, which helped stabilize the market. And the government tried to quell foreclosures.
If the housing market is hit hard again in a recession, the government would have fewer options. The Fed owns nearly a trillion dollars’ worth of mortgages. The Treasury has spent $130 billion on rescuing Fannie and Freddie, which are legally required to start shrinking this year. The government will still be able to try to use Fannie and Freddie — which aren’t counted as part of the budget — to help the housing market, but officials are unclear about what could be done to make a major difference.