Thread: Fed Primed to Cut Key Interest Rate Tuesday

Fed Primed to Cut Key Interest Rate Tuesday

MoneyNews
Tuesday, March 18, 2008
WASHINGTON -- The Federal Reserve is primed to aggressively cut a key interest rate even lower on Tuesday, racing to contain spreading financial fires that threaten an economic meltdown.

President Bush declared "we're in challenging times" and huddled Monday with top economic officials — including Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox.

On Wall Street investors were still skittish. The Dow Jones industrials, in an erratic session, closed up 21.16 points, after having plunged nearly 200 points early in the day. Other stock indexes fell.

With the quick collapse of the investment bank Bear Stearns, fears are mounting about whether other financial companies may fall. Many believe the country has already sunk into recession and all the problems — if not contained — will deepen and prolong the pain.

"The Fed is on high alert — something you don't see but once every quarter century; maybe, in this case, since the Great Depression. This is a very unusual period," said Mark Zandi, chief economist at Moody's Economy.com.

That's because the Fed is having to fight multiple battles at the same time: a housing collapse, a severe credit crunch and Wall Street turmoil that threatens the stability of the entire U.S. financial system. All those problems feed on each other, creating a vicious cycle that can be hard for the Fed and other Washington policymakers to break. The weight of those troubles is like a millstone on the ailing economy.

"Now the issue is fighting the deeper recession," said Brian Bethune, economist at Global Insight. "It has kind of moved to another level. The fires are spreading," he said.

To limit the damage, Bernanke and his colleagues may ratchet down a key interest rate, now at 3 percent, by as much as a full percentage point, to 2 percent, which would put that rate at the lowest it has been since late 2004. Because that rate affects a wide range of rates charged to millions of consumer and businesses, it is the Fed's most potent tool for reviving economic activity.

If that happens, commercial banks' prime lending rate on certain credit cards, home equity lines of credit and other loans would drop by a corresponding amount to 5 percent, from 6 percent currently. The Fed's goal, since embarking on a rate-cutting campaign in September, is to induce people and businesses to boost spending, thus bolstering the economy.

However, with the panicky mind-set that has swept over investors since last summer, credit — even at a lower cost — has become harder and harder to get as financial institutions, which racked up huge losses due to soured investments in mortgage-linked securities, became increasingly wary of lending and hoarded cash. So the Fed took a series of other unconventional maneuvers to deal with those problems and to restore confidence.

The Fed, in a bold action on Sunday, agreed for the first time to let big investment houses get emergency loans directly from the central bank. The new lending facility — similar to one that's been available to commercial banks for years — started Monday and will continue for at least six months. It marked the broadest use of the Fed's lending authority since the 1930s.

Also Sunday, the Fed approved a $30 billion credit line to engineer the takeover of Bear Stearns.

Senate Majority Leader Harry Reid, D-Nev., was critical. "The Federal Reserve's latest actions appear to shift large risks to taxpayers, who may find themselves on the hook for billions in worthless securities."

Countered Paulson: "Bear Stearns had a liquidity crisis, and so we felt it was very important that this be resolved as a way to minimize impact on our economy ... This is the right outcome."

Democrats accused Bush of not doing enough to relieve the broader economic situation.

"Now we are in the soup and we better get ourselves out of it before the consequences get drastic," Democratic presidential contender Hillary Rodham Clinton told reporters. Barack Obama said: "History will not judge President Bush kindly for his failure to act in a way that could've prevented or alleviated this economic crisis."

House Speaker Nancy Pelosi, D-Calif., who is advocating extending unemployment benefits and other relief measures, said "more must be done to begin to reverse the economic mismanagement of the past seven years."

The new lending facility — described as a cousin to the Fed's emergency lending "discount window" for banks — is geared to give financially-squeezed major investment houses a source of short-term cash on a regular basis.

That's important because those big investment houses have key roles in the financial system. If one fails or is having difficulty, it could put the whole financial system in jeopardy. These big firms have complex relationships with many players in the system, including hedge funds, commercial banks and others.

A range of collateral _ including investment-grade mortgage backed securities _ will be accepted to back the overnight loans. The Fed also on Sunday lowered its emergency lending rate to banks _ and now to big investment houses _ by a quarter-point to 3.25 percent.

"These steps will provide financial institutions with greater assurance of access to funds," Bernanke told reporters in a conference call Sunday evening. Bernanke, a scholar of the Great Depression, has been stretching for innovative ways to deal with the credit and financial crises.

The Fed has the power "in unusual and exigent circumstances" to expand emergency lending to other types of companies and even to individuals if they are unable to secure "adequate credit" from other banking institutions. Thus, economists said there's the possibility that — if current relief maneuvers weren't sufficient — the Fed could extend emergency credit to a wider variety of recipients.

The Fed acted on Sunday just after JPMorgan Chase & Co. agreed to buy rival Bear Stearns Cos. for $236.2 million in a deal that represents a stunning collapse for one of the world's largest and most venerable investment houses. Just on Friday the Fed had raced to provide emergency financing to cash-strapped Bear Stearns through JPMorgan. Days earlier the Fed announced a set of other unconventional steps to thaw out a credit market in danger of freezing shut.

The flurry of unconventional steps may risk putting the public into a more skittish frame of mind, some said.

"It all kind of sends a conflicting message — making people more nervous," said Bethune. "Why is the Fed every week coming out with another major injection of liquidity or a bailout? What are they doing in Washington?"

In communicating with Wall Street and Main Street, sometimes fewer public utterances by Fed officials may be prudent during turbulent times. "Some talk is best left with your wife over a glass of wine in the evening," Bethune said. "Talking publicly sometimes is not the way to go."

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