WASHINGTON - The Federal Reserve lowered its benchmark lending rate by one-quarter of a percentage point yesterday, which helped consumers but sent stocks plunging because Wall Street had been hoping for more.
The Fed's quarter-point cut in the federal funds rate - which banks charge one another for overnight loans - dropped it to 4.25 percent. Commercial banks quickly matched the move by lowering their prime rate, which they charge their best customers, one-quarter of a percentage point, to 7.25 percent.
The Fed's third consecutive rate cut in recent months was welcome, but many on Wall Street were disappointed that the Fed did not also sharply lower the discount rate that it charges private banks for short-term loans. The Fed did cut that rate by one-quarter of a percentage point, to 4.75 percent, but many had clamored for a half-point cut or more to spur sluggish bank activity.
After the Fed's rate cuts, stocks fell sharply. The Dow Jones industrial average closed down 294.26 points at 13,432.77, the S&P 500 was down 38.31 points to close at 1,477.65, and the Nasdaq composite index fell 66.60 points to close at 2,652.35. Each index was down more than 2 percent.
The Fed's decision was not unanimous. The president of the Boston Federal Reserve Bank, Eric Rosengren, voted against the decision, arguing for a deeper cut.
In a statement, the Fed governors acknowledged that the risks of slowing growth and rising inflation were no longer in balance and that turmoil in credit markets was creating great uncertainty.
"Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks," the Fed statement said. "Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time."
The reference to moderate growth reflects the Fed's view that the economy may be in somewhat better shape than headlines suggest, said David Wyss, chief economist for the rating agency Standard & Poor's, of New York.
"Ninety-four thousand new jobs [in November], 4.7 percent unemployment, manufacturing numbers that are soft but not terrible, early [Christmas] retail sales up - except for housing, which is obviously a mess - the rest of the economy doesn't look all that bad yet," he said.
Keith Hembre agreed that the Fed appeared more optimistic than the markets. The chief economist for First American Funds, a Minneapolis-based mutual fund, said he had hoped for deeper rate cuts.
"They weren't aggressive. They failed to meet either the expectation or hopes that had been built into the market," he said.
At the heart of today's economic problems are a severe housing slump and the packaging of shaky mortgages into bonds of dubious value. Banks holding those suspect notes fear that they will have to write down their asset values, and rather than take on more risks with new loans, some are hoarding their cash reserves. That has spawned mounting concerns that credit markets - where banks make short-term loans to corporations for funding day-to-day operations - may cease functioning as they should.
That is why some economists want the Fed to slash the discount rate more aggressively. The rate at the Fed's discount window is higher than in private markets to bring the U.S. government a premium when banks borrow from the lender of last resort. But if the Fed lowered that discount rate, perhaps even below the federal funds rate, it would remove the stigma of borrowing from the government, spur borrowing, and enliven credit markets.
In the Fed's Words
From yesterday's Federal Open Market Committee statement on the economy and interest rates:
Incoming information suggests that economic growth is slowing. . . . Moreover, strains in financial markets have increased.
Today's action . . . should help promote moderate growth.
Some inflation risks remain.
The committee will continue to assess the effects of financial and other developments on economic prospects, and will act as needed to foster price stability and sustainable economic growth.