BERNANKE’S BIG MOVE

The Star-Ledger, January 23rd, 2008

The Star-Ledger Archive COPYRIGHT © The Star-Ledger 2008

Date: 2008/01/23 Wednesday Page: 001 Section: NEWS Edition: FINAL Size: 1084 words

Fed leaps to prevent panic

By SAM ALI STAR-LEDGER STAFF

It was the equivalent of pulling the emergency brake on a speeding train.

With stock markets in free fall around the world, the Federal Reserve announced a sharp cut in interest rates yesterday, slashing its benchmark rate by a bold three-quarters of a point. It was the first emergency rate cut by the central bank since the Sept. 11, 2001, terror attacks and the largest single-day cut since 1982.

And it definitely produced the desired effect.

Before the opening bell on Wall Street, U.S. stocks had been poised to plummet, a day after markets from Mumbai to London tumbled amid fears a U.S.-led recession would hurt the global economy. After a sharp sell-off at the start of trading, however, the Dow Jones industrial average regained much of its lost ground, finishing down a little more than 1 percent.

But for many economists, the Fed's sudden move to slash the so-called federal funds rate to 3.5 percent raised more questions than it answered.

Was it a tacit admission by the Fed that it had misjudged the severity of the financial crisis and was now trying to play catch-up? Or was the Fed in full panic mode because, in the words of one economist, "they know something we don't know"?

The announcement certainly caught financial markets by surprise, coming seven days before the Fed's normally scheduled rate-setting meeting.

Dirk van Dijk, chief equity strategist at Zacks Equity Research, said the Fed's reaction smelled of fear.

"I was expecting a rate cut at the Fed's next meeting, but coming in and cutting rates so close to their regular meeting says to me that Ben Bernanke needed a new pair of underwear," he said.

In addition to cutting the fed funds rate – what banks charge each other for overnight loans – the Fed said it was reducing the discount rate, the interest it charges to make direct loans to banks.

Commercial banks responded to the Fed's action by announcing similar cuts of three-quarters of a percent on the prime lending rate, the benchmark for millions of business and consumer loans. The action will mean the prime lending rate will drop to 6.50 percent, from 7.25 percent, making it cheaper to finance everything from cars to home improvements.

"One is tempted to say 'Better late than never,'" said Bernard Baumohl, the managing director of Princeton-based Economic Outlook Group. "What has been missing for so long is the recognition among policymakers that this is not some garden-variety recession looming over the world economy.

"What's pushing the global economy toward recession this time is something much more serious. It's the rapid deterioration of the international financial system."

CASCADING EFFECT

What began as a "contained" subprime mortgage problem in the United States back in August has blown up into a full-fledged global credit crisis, with the fallout being felt as far away as China. Yesterday trading in the Bank of China was suspended on reports it would be the latest to take write-downs, totaling $8 billion, on its subprime mortgage holdings.

And there was no sign of when it will all end.

Experts said the global sell-off in stocks the past two days was triggered in part by the meltdown in "monoline" insurers, including New York-based Ambac, the nation's second-largest insurer of bonds. On Friday, Ambac lost its AAA rating over concerns the company no longer had enough capital to guarantee billions of dollars in bonds tied to subprime mortgages. Van Dijk said the downgrade had a cascading effect, hurting the credit of many of the bonds Ambac insures.

In response to the growing nervousness in credit and stock markets, congressional Democratic leaders said yesterday they feel urgency to enact an economic stimulus plan and are confident they can work with President Bush to get one done quickly.

Senate Majority Leader Harry Reid said the goal is to get a deal through Congress and on Bush's desk within roughly three to four weeks, before lawmakers break for the Presidents Day recess. Earlier, Bush said he was confident Congress and the administration would be able to approve a stimulus package to jump-start the economy and calm fears of recession that have shaken financial markets worldwide.

Because U.S. markets were closed Monday in observance of Martin Luther King Jr. Day, Wall Street was girding for a panic sell-off yesterday. As expected, major U.S. stock indexes plummeted after the opening bell, with the Dow falling 465 points and the Nasdaq dropping 118 points, all within the first four minutes of trading. By the end of the day, however, the markets rebounded off their lows, with the Dow finishing down a more bearable 128 points at 11,971.

"It was a huge relief," said van Dijk. "Everybody was holding their breath to see how bad things would be at the close. So closing where we are right now, everyone will count this as a huge psychological victory. The Fed stepped in and blasted it with both barrels and was able to have an effect."

MORE HOUSING WORRIES

Stocks have been beaten down for months amid falling housing prices and a mortgage crisis that began with a stream of failed home loans to consumers with poor credit.

The Dow is down nearly 10 percent since the beginning of the year – logging its worst-ever first 14 trading days of the year. It is down more than 15 percent since its record close of 14,164.53 on Oct. 9, and is at its lowest point since Oct. 17, 2006.

Investors are well aware that housing worries remain. Many adjustable-rate mortgages – similar to those that went bad last year – will still be adjusted higher, and home prices are expected to keep falling this year. Financial companies have lost billions of dollars because of those mortgages, retail sales are weak, and the unemployment rate is beginning to rise.

While many economists now view a recession as a near-certainty, the Fed's bold action sends a signal that policymakers will do whatever is necessary to stop the slide in market confidence and minimize damage to the economy.

"What's made matters worse is the seeming lack of urgency by policymakers in Europe and in the U.S. to get in front of this very serious crisis," Baumohl said. "With any luck, that may be about to change."

Sam Ali may be reached at sali@starledger.com.

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