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Dodd denies 'political pressure' but still expects rate cut

Section: Daily Dispatches

Dodd Denies 'Political Pressure' on Rates

By Edward Luce and Krishna Guha
Financial Times, London
Tuesday, August 21, 2007

WASHINGTON -- U.S. Sen. Christopher Dodd, the chairman of the Senate Banking Committee, was on Tuesday at pains to emphasise that he was not applying "political pressure" on the US Federal Reserve to cut interest rates.

But at the end of an unusual 45-minute meeting with Ben Bernanke, chairman of the Fed, and Hank Paulson, the Treasury secretary, Mr Dodd made it clear that he expected that a cut in the federal funds rate -- the most basic tool of monetary policy -- would follow from the Fed's 25 basis-point cut in the discount rate last Friday.

"I asked Chairman Bernanke if he would use all the tools available to him and he said: 'Absolutely,'" said Mr Dodd, who is also a Democratic presidential hopeful for 2008. "Historically the federal funds rate has tended to follow" movements in the discount rate.

With repossessions of US homes at a 37-year high and housing starts at a 10-year low, political pressure is growing on the Fed to take stronger action to ease the credit crunch. RealtyTrac, a seller of data, on Tuesday said that home repossessions doubled last month from the previous July -- with 179,599 homeowners receiving foreclosure notices.

Most leading politicians have stopped short of calling on Mr Bernanke to ease monetary policy to help revive the secondary mortgage market. As an independent institution, the Fed has always jealously guarded its autonomy in setting interest rates.

But a growing minority, including U.S. Rep. Barney Frank, the Democratic representative from Massachusetts, and Sen. John McCain, the Republican presidential candidate, have directly called on Mr Bernanke to cut rates by up to half a percentage point.

At the most recent Democratic presidential debate in Iowa on Sunday, some of the candidates came close to adding their voices. Bill Richardson, the former governor of New Mexico, described the crisis as the "Hurricane Katrina of the mortgage-lending industry."

Sen. Joe Biden, D-Delaware, said the crisis was "almost as deep in terms of dollars, not liability, as the savings and loans crisis" of the late 1980s. Both Sens. Barack Obama and Hillary Clinton, the two Democratic presidential front-runners, called for more liquidity to be pumped into the market.

But it is the Bush administration that has borne the brunt of criticism for the unfolding crisis. "Applying political pressure on the Fed to change monetary policy is almost always counter­productive," said Alice Rivlin, a former deputy chairman of the Fed now at the Brookings Institution.

Ms Rivlin said Mr Bernanke would be mindful of the criticism of the Fed's response in 1998 to the collapse of Long-Term Credit Management, the large hedge fund, when it cut interest rates only to come under fire for having stoked the equity market bubble. "Some people suggested that the right thing to have done in 1998 would have been to cut only the discount rate."

Lawmakers are much less circumspect in their attacks on the Bush administration and specifically Mr Paulson for having allegedly stood by while the fire has spread through low-income communities across the US. "I left with the sense that the Fed gets it and understands it," said Mr Dodd, after yesterday's meeting. "I am still concerned that the Treasury does not understand the importance of this issue."

The principal dividing line is over Mr Paulson's reluctance to accede to Democratic demands to lift the portfolio lending caps on Freddie Mac and Fannie Mae, the government-­sponsored mortgage finance companies. Officials say lifting the ceiling would lead to an even greater concentration of risk in two behemoths with mortgage investment limitations of $727 billion and $724 billion respectively.

There is resistance within the administration to the principle of providing taxpayer-subsidised rates in a market crisis. But Mr Paulson on Tuesday signalled greater flexibility than before. "The president wants us to be clearly focused on actions that can be taken, things we can do, to help mortgage holders who are in danger of losing their homes."

On some questions, such as tightening standards for the subprime market, there is a broad consensus between Congress, the Fed, and the administration. But that will have little impact on the existing crisis, which looks likely to be a dominant theme when Congress returns from its summer recess in two weeks.

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