Fed Cuts Key Rate Another .75 percent

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RISMEDIA, March 19, 2008-(MCT)-All eyes were on the Federal Reserve Tuesday as its policy-making committee tries to spark the sick U.S. economy back to health, slashing short-term interest rates by three-fourths of a percentage point. The cut brings the federal funds rate to 2.25 percent.

As recently as Friday, investors were signaling that they expected the Fed to cut rates by half a percentage point. But that was before the spectacular weekend collapse of investment bank Bear Stearns, whose value stood at $3.5 billion on Friday before it was sold Sunday night for just $236 million to J.P. Morgan Chase after a run on it by investors.

The Fed brokered the $2-a-share sale of Bear Stearns. Shares of J.P. Morgan Chase, which purchased it, rose 11% on Monday, pulling the Dow Jones Industrial Average into positive territory. The Dow closed Monday up 21.16 points to 11,972.25.

Sunday night the Fed also widened access to credit like never before in a muscular bid to keep banks and other institutions lending and corporations and investors borrowing.

“These moves by the Fed are a prelude to additional bold action to reduce rates,” said Brian Bethune, U.S. economist with forecaster Global Insight in Lexington, Mass. He predicted a full percentage-point cut.

As of Tuesday morning, Wall Street was all but certain that a cut of at least three-quarters of a percentage point was coming and hopeful for a full percentage point, which would have put the Fed’s bellwether short-term “federal funds” rate at 2%. That would bring the prime rate, which banks charge to their best customers, down to 5%.

“We continue to expect the funds rate eventually will reach 1.5 percent,” said Mickey Levy, chief economist of Charlotte, N.C.-based Bank of America, in a note to investors.

What such low interest rates would mean for consumers isn’t clear, since turmoil in the credit markets means that banks aren’t lending. Instead, they are hording capital to shore up their balance sheets.

Lower rates could bring down some variable rates on credit cards, but credit card companies have been raising rates out of fear that the economic downturn will lead to more loan defaults.

The falling rates could help ease the sting for homeowners whose adjustable-rate mortgages are about to reset higher. But many of these loans adjust based on factors not directly affected by the Fed’s benchmark rate.

The Fed has already cut the funds rate from 5.25% last September to 3% in January. So far that’s done little to revive the U.S. economy, which has been in increasing turmoil since August.

The Fed has also made available more than half a trillion dollars in credit to banks and securities dealers in hopes of spurring lending and preventing credit markets from seizing up.

There were glimmers of hope Monday as the difference between yields on mortgage bonds and other safer financial instruments-called the spread-narrowed. One day does not make a trend, but it’s a possible sign that the fear gripping credit markets could be easing.

“These areas have tended to lead other areas of credit, so if we can hold onto these recent gains, there should be improvement in the tone of risk in general,” said Michael Darda, chief economist for MKM Partners, a stock trader and research firm in Greenwich, Conn.

Lyle Gramley is less optimistic. He’s a former Fed governor and has spent more than 50 years studying financial markets.

“If you look back at post-war recessions, I thought I knew that when the Fed pushed the accelerator, we’d leave problems behind. We just don’t know that now–that’s one of the most scary parts of the situation that we find ourselves in,” Gramley said. He believes that taxpayer dollars and more government intervention are needed.

President Bush and Treasury Secretary Henry Paulson have made clear that they’ll oppose bailouts of lenders. In a brief statement after meeting with his economic team on Monday morning, Bush said, “One thing is for certain, we’re in challenging times. But another thing is for certain: We’ve taken strong, decisive action.”

Monday could have been a far different day if not for bold action by the Fed to broker the sale of Bear Stearns in order to prevent its bankruptcy.

“To allow this to go to bankruptcy would have allowed systemic problems that could have been massive,” Senate Banking Committee Chairman Christopher Dodd, D-Conn., said in a conference call to U.S. reporters from Belgium.

The Fed on Sunday night also made a quarter-point cut in its discount rate, which it charges as the lender of last resort to banks. It extended the loan repayment time frame to 90 days from the normal 30-day terms, accepted as collateral a broad range of financial instruments including mortgage bonds, and made credit available to not just investment banks but also securities dealers.

Although U.S. stocks averted disaster Monday, share prices for financial sector players were hammered as concerns persisted about whether other big players were vulnerable to a run by investors, as Bear Stearns was.

“You know the old saying about cockroaches, there’s never just one,” said Howard Simons, president of Rosewood Trading, an economic research firm in Glenview, Ill. “One thing we’ve learned the hard way over the past year is, just when you think there’s no more bad news, there’s more bad news.”

© 2008, McClatchy-Tribune Information Services.

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