Fed’s Action Stems Sell-Off in World Markets


Richard Moore

More debt to solve the problem of bad debts?? sounds crazy to me - rkm

January 23, 2008

Fed¹s Action Stems Sell-Off in World Markets

WASHINGTON ‹ The Federal Reserve, confronted by deepening panic in global 
financial markets about a possible recession in the United States, struck back 
on Tuesday morning with the biggest one-day reduction of interest rates on 
record and at least temporarily stopped a vertigo-inducing plunge in stock 

The unexpected decision came after a rare, hastily called policy meeting by 
videoconference on Monday evening, and it reduced the Fed¹s benchmark overnight 
lending rate by three-quarters of a percentage point, to 3.5 percent.

The Fed¹s move was prompted in part by turmoil in global markets on Monday, a 
holiday in the United States. Shortly after lunch that day, the Fed chairman, 
Ben S. Bernanke, canceled a planned trip to New York and started organizing the 
impromptu meeting of the Fed officials who decide interest rate policy. The 
Treasury secretary, Henry M. Paulson Jr., watching the same market turmoil, was 
anxious enough that he called President Bush at the White House.

In a statement accompanying the Fed¹s decision, which was announced about an 
hour before the stock market opened for trading, officials hinted that they 
might reduce rates yet again at their scheduled meeting next Tuesday and 

The magnitude of the Fed¹s rate cut helped reverse what began as a horrendous 
day in the stock markets. European and Asian stock prices had already plunged 
for the second consecutive day, and the Dow Jones industrial average fell 464 
points ‹ about 5 percent ‹ as soon as markets opened in New York.

By the close of trading Tuesday, stock prices, after gyrating wildly, had clawed
much of their way back. Shares of banks and insurers of mortgage-backed 
securities, which had been battered in recent days, were among the day¹s biggest
gainers. Asian markets seemed to calm Wednesday morning with most exchanges 
opening higher.

³Wall Street is incredibly jittery,² said Len Blum, a partner at Westwood 
Capital, an investment bank in New York. ³They don¹t know how to react to it. 
The last time they did a rate cut in between meetings was after Sept. 11, 2001.²

The Fed¹s move came as Mr. Bush and Congressional leaders pledged to work 
together on a bipartisan measure to jolt the economy with about $145 billion in 
tax rebates, tax breaks for businesses and possibly additional payments to 
low-income people.

³I believe we can find common ground to get something done that¹s big enough and
effective enough,² Mr. Bush told reporters. Senator Harry Reid of Nevada, the 
Senate majority leader, said he hoped Congress could pass a bill before the 
recess for Washington¹s Birthday on Feb. 18.

Still, it was a nerve-racking day on Wall Street, with the Dow ending down 128 
points, or about 1 percent. Even after the rebound, the major market indexes are
down about 10 percent so far in January and even further off their recent highs 
in October. The Nasdaq composite index, which mostly reflects technology stocks,
is off 18.3 percent.

Economists said it remained far from clear that the United States would avoid a 
recession, either because the Fed and the Bush administration had moved too 
slowly or because the economy¹s woes were too acute to solve quickly and 

³This is unique in the modern history of the Fed,² said Vincent Reinhart, a 
resident scholar at the American Enterprise Institute who was director of the 
Fed¹s division of monetary affairs from 2001 to 2007.

Even so, it may not be enough to head off a downturn: changes in interest rates 
usually work with a lag time of at least six to nine months, and many economists
say that a recession may already have begun.

Citigroup, citing the severely depressed housing market, the credit squeeze and 
high energy prices, predicted on Tuesday that the economy was about to start 
shrinking and would barely eke out any growth for all of 2008.

³Academic definitions aside, we¹ll call that a recession,² wrote Steven Wieting,
a Citigroup economist.

Fed officials stopped well short of such gloom and doom, but they made it clear 
they had been alarmed by both worsening data in the United States and the 
worldwide stock panic that began on Monday.

³Broader financial market conditions have continued to deteriorate,² the central
bank said, noting that credit conditions have continued to tighten for many 
businesses and households, that the housing market continues to spiral downward 
and that job creation has slowed.

³Appreciable downside risks to growth remain,² the central bank said, its most 
forceful acknowledgment yet that the United States economy is on the brink of a 
recession as a result of the triple punch from the severe downturn in housing, 
the fallout from soured mortgages and the added blow of high oil prices.

The move represented a dramatic shift for Mr. Bernanke, who took over as Fed 
chairman two years ago. Mr. Bernanke, a former professor of economics at 
Princeton, had resisted calls for a big rescue effort by the Fed and favored a 
less personalized approach to monetary policy than his predecessor, Alan 

But when Mr. Bernanke called policy makers together for an emergency meeting on 
Monday night, with regional Fed presidents participating over secure 
videoconference lines, he embarked on the boldest policy move in years.

This was only the fifth time that the Federal Reserve had reduced the overnight 
federal funds rate outside of its regularly scheduled policy meetings. It did so
in October 1998, during Russia¹s financial collapse, two more times in early 
2001 as the economy was sliding into a recession and once more after the 
terrorist attacks on Sept. 11, 2001.

This was also the central bank¹s biggest one-day cut in the federal funds rate, 
which is its target for the overnight rate at which banks lend their reserves to
each other. Until Tuesday¹s reduction of three-quarters of a percentage point, 
the biggest individual cuts were by half a point.

The only comparable rate cuts were in 1982 and 1984, when the central bank, 
which was following different procedures, reduced the overnight rate by more 
than one percentage point over the span of several weeks.

Fed officials clearly hoped that a bold and decisive act would calm investors 
and restore confidence in credit markets, where fears about soaring defaults on 
subprime mortgages have increasingly forced banks to curtail their lending in 
other areas.

But while investors did react with relief, the Fed¹s move also seemed to 
validate the fears that the economy is closer to a recession than policy makers 
had thought.

On Wall Street, many if not most analysts had assumed that the central bank 
would reduce overnight rates by half a percentage point at the next policy 
meeting. But with the meeting only one week away, few investors expected the Fed
to cut rates before then ‹ a move that could easily be seen as panicky behavior.

The Fed move carries other risks. Reducing the interest rate could push up the 
inflation rate, even as it bolsters consumer spending.

In a speech this month, Mr. Bernanke strongly hinted that the Fed would reduce 
rates again at the policy meeting scheduled for next week. Mr. Bernanke had 
clearly not expected to move before the meeting.

But the Fed chairman became notably more worried by late last week. Most of the 
incoming economic data pointed toward a slowdown. On top of rising unemployment 
in December and depressed holiday sales at many major retailers, there were 
signs of a worsening credit squeeze, new declines in housing starts and worries 
about the companies that insure mortgage-backed securities.

Mr. Bernanke and other Fed officials contend they do not make decisions in order
to calm financial markets. But analysts say they became alarmed about last 
week¹s stock market plunge and Mr. Bernanke was even more alarmed by the huge 
drops Monday in foreign stock markets like Frankfurt, London and Hong Kong.

The drop in foreign stock prices undermined one of the last bright spots for the
American economy ‹ the prospect that a strong global economy, combined with a 
cheap American dollar, would spur enough export growth to offset a weakness at 

The growing sense of crisis added urgency to efforts by Mr. Bush and 
Congressional leaders to bury their political animosities and agree on a 
short-term fiscal- stimulus package.

A spokesman for Mr. Paulson said that he had been busy reaching out to 
Congressional leaders all last week and that the market declines of the last few
days had not by themselves forced him to quicken the pace.

Mr. Bush and Congressional leaders have both talked about a package that would 
inject about $150 billion in additional money into the economy. That would equal
about 1 percent of the nation¹s economic output, which economists and Fed 
officials said could make a difference if the money gets into people¹s hands 
quickly enough.

But even if Congress passes such a measure by mid-February, which would require 
Republicans and Democrats to suppress their animosities and their contrasting 
economic approaches, the earliest that tax rebates would actually reach people 
would probably be this summer. At that point, it would help soften the blow but 
a recession might have already been under way for months.

Ultimately, it is the Federal Reserve that has the most power to avert or soften
a recession. But its power is finite, and its primary tool ‹ lower interest 
rates ‹ takes time to work.

³Monetary policy works with a lag,² said Mr. Reinhart, the former top Fed 
official. ³There¹s nothing the Fed can do to prevent a recession if it is coming
in the first half of this year.²

Steven R. Weisman and Carl Hulse contributed reporting.

Copyright 2008 The New York Times Company

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