Who's Raising Your Rates?

By John Greenwald

Who are these guys, and why are they jacking up the nation's rent, so to speak, by raising the cost of credit-card, car-loan, home-mortgage and other debt?

In one sense, last week's stiff interest-rate hike by the Federal Reserve's little known Federal Open Market Committee was a no-brainer, given the still sizzling growth of the U.S. economy. But in another sense, the panel's increase in the so-called federal-funds rate from 6% to 6.5% marked a spectacular wager on your future, with your money, by 10 unelected and largely unknown officials operating behind closed doors. By raising the rate that underpins most other borrowing costs to its highest level in nine years, the committee is hoping--make that praying--to cool the economy and forestall ruinous inflation without jeopardizing the longest-running expansion in U.S. history.

Such high-stakes crapshoots are routine for the FOMC, a secretive body whose ability to raise or lower interest rates makes it perhaps the second most powerful group of appointees in Washington--behind only the Supreme Court. Led by Federal Reserve Chairman Alan Greenspan--the one member with star wattage--the panel gathers eight times a year around a 27-ft. 11-in. black granite and mahogany table to issue diktats that are feverishly parsed on Wall Street and around the world. The members are the seven Fed governors, plus five of the 12 regional Federal Reserve Bank presidents at a time. (Two governors' seats are currently vacant; a Ph.D. in economics will help if you'd like to apply.) The remaining bank chiefs are nonvoting but vocal participants.

While the press tends to treat Greenspan as the sole author of interest-rate policies, insiders and Fed watchers know that is hardly the case. Greenspan, actually considered a moderate among the group's inflation hawks and doves, is clearly first among equals and exerts a considerable influence over the FOMC. But as a careful consensus builder, he is also at pains to stake out positions that the rest of the committee can live with--and thereby avoid any risk of being embarrassed by a close vote. "There is a limit to how far the chairman's influence can be extended," Fed governor Laurence Meyer recently explained. "A good chairman sometimes has to lead the FOMC by following the consensus within the committee."

What confronted this increasingly hawkish panel last week was a maverick economy that simply refuses to do what it's told. The Fed had raised rates a quarter of a percent--or 25 basis points, in the lingo--no fewer than five times since last June, with little tangible impact on either GDP growth or unemployment. Joblessness stood at just 3.9% in April, its lowest level in three decades. This persistent lack of idleness sent shivers up the spines of FOMC members, who fear that tight labor markets will lead to inflationary wage increases. To make matters worse, from a Fed perspective, the economy expanded at a brisk 5.4% clip in the recent first quarter, well above the presumed 3.5% to 4% "speed limit" that many economists have viewed as the upper range for growth without inflation.

"There is real frustration within the FOMC," says Fed watcher David Jones of the Aubrey G. Lanston investment firm. "Borrowing costs have been going up for more than a year, and yet no one seems to care. The Fed is asking 'What does it take to get the consumer's attention?'" The FOMC's answer: its first 50-basis-point increase in the federal-funds rate--the interest that banks charge one another for overnight loans--in five years, plus a stern warning that you can expect another boost when the committee meets again next month. (What should you do about your finances? See following story.)

Ironically, the Fed's get-tough stance came just hours after a Commerce Department report showed that the "core" rate of inflation (the Consumer Price Index with volatile food and energy prices omitted) had fallen to an annual rate of 2.4% in April, down from 4.8% in March. That led Senator Tom Harkin, an Iowa Democrat, to denounce the FOMC increase as "clearly excessive" at a time when "accelerating inflation is not apparent." If this continues, says Harkin, "our economy is going to bleed to death." In other words, the Democrats need a slowing economy in an election year like they do another Monica.

Last week's hawkish increase marked a clear departure from the gradualist policies that Greenspan had championed for years. "Three years ago," recalls former Fed vice chairman Alice Rivlin, "some [FOMC] members were worried about the economy overheating. But I wasn't, and neither was Greenspan." Both argued that technology was making workers more productive and stifling inflation. The FOMC thus opted for a string of small rate hikes that became a hallmark of Greenspan's cautious approach to monetary policy.

But this spring the chairman reset his course, and other doves on the panel found themselves in full retreat. The tough new thinking was reinforced by the arrival of voting members like Jerry Jordan, president of the Federal Reserve Bank of Cleveland (Ohio). "There is [agreement] right now that the economy is growing too rapidly," Rivlin says. The moral: "If you step on the brakes a little and the car doesn't slow down, then you need to step on them a bit harder the next time."

The stubbornly strong growth convinced Robert McTeer, president of the Federal Reserve Bank of Dallas, that larger rate increases may be appropriate this year. McTeer, whose voting term expired last December, had been the only panelist to dissent from Fed tightening in 1999. "I believed, unlike some others, that productivity gains were keeping inflation sufficiently in check," McTeer says. "But as we moved into 2000, the signals from the economy were fairly clear cut. There was little question in anyone's mind that inflationary pressures were building."

Nor was there much doubt on Wall Street about what the Fed panel was planning. Just two weeks ago, Robert Parry, the president of the Federal Reserve Bank of San Francisco and a voting member, strongly hinted at the outcome by declaring in a speech "We have moved cautiously, but that doesn't mean we only have a single note to play."

The curtain went up promptly at 9 a.m. last Tuesday when Greenspan stepped through the doorway that connects his office to the boardroom to signal the start of the FOMC meeting. (The room sports a large map of the U.S. at one end and, at the other, a fireplace with a bronze sculpture of Demeter, the Greek goddess of agriculture and fertility.) Instead of taking his usual place at the head of the table, Greenspan pulled out a chair in the middle--a move that highlighted his desire to forge a consensus but set off a round of musical chairs to preserve the customary seating plan in relation to the chairman.

The meeting commenced, as all do, with the approval of the minutes of the last gathering--this is a government bureaucracy, after all--and some staff reports. Then a "go-round" took place in which the presidents and Fed governors discussed the economic outlook, each having had access to two briefing books bulging with fresh data and policy choices. Then it was Greenspan's turn, the meeting's moment of truth, when he delivers his interest-rate recommendation and the rationale for it. "Greenspan always has some striking insight, or some number that no one else has ever heard of before," notes Fed watcher Jones.

The complete transcript of what the chairman and other FOMC members said won't be released for five years, yet Fed watchers have little doubt that most speakers expressed exasperation at the refusal of the expansion to knuckle under to past rate increases and stressed their determination to try again.

Nor did students of the Fed see any sign of dissent from the doves. "In the old days," says economist Kevin Flanagan of Morgan Stanley Dean Witter, "there was a debate over who was an influential hawk and who an influential dove." But today, Flanagan notes, any policy disagreements tend to vanish into Greenspan's carefully nurtured consensus. Concurs Fed governor Meyer, who has a reputation as a hawk's hawk on inflation: "Many members will voice some disagreement with the chairman's view in the go-rounds. But many of those will vote with the chairman in the end."

Having done so, the most powerful monetary movers and shakers on the planet invariably line up for an informal boardroom lunch. Reaching for paper plates and plasticware, the FOMC members help themselves to a buffet that last week featured cold cuts, soft drinks, salads and chocolate-chip cookies--a special favorite of many members. Then they headed back to their offices to watch Wall Street's reaction, while bankers across the country adjusted the loan-rate signs in their windows.

--Reported by Bernard Baumohl and Eric Roston/New York and Adam Zagorin/Washington

With reporting by Bernard Baumohl and Eric Roston/New York and Adam Zagorin/Washington