Looking for the Cure

WASHINGTON - The Federal Reserve is primed to aggressively cut a key interest rate again this afternoon as it races to contain spreading financial fires that threaten an economic meltdown.

At the White House yesterday, President Bush declared "we're in challenging times" and huddled with top economic officials - including Fed Chairman Ben S. Bernanke, Treasury Secretary Henry M. Paulson Jr., and Securities and Exchange Commission Chairman Christopher Cox.

Meanwhile, investors remained skittish about prospects for the economy and the stock market. 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 Cos. Inc. in the last week and its Fed-supported acquisition by JPMorgan Chase & Co., fears are mounting about whether other financial companies may fall. Many say they believe that the country already has sunk into recession and that all the problems, if not contained, will deepen.

"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 in West Chester, Pa.

That is because the Fed is fighting multiple battles simultaneously: a housing collapse, a severe credit crunch, Wall Street turmoil that threatens the stability of the entire U.S. financial system, a falling dollar, and rising prices for many commodities.

To limit the damage, Bernanke and his colleagues may cut a key interest rate, now at 3 percent, by as much as a full percentage point, to 2 percent, which would put that overnight loan rate at the lowest it has been since late 2004.

Because that rate affects a wide range of rates charged to millions of consumers and businesses, it is the Fed's most potent tool for reviving economic activity. The Fed's policymaking group, the Federal Open Market Committee, meets today to decide what to do.

If it lowers the key rate, it would be the sixth reduction since September, and commercial banks' prime lending rate on certain credit cards, home equity lines of credit and other loans would drop a corresponding amount from 6 percent currently.

The Fed's goal, since starting a rate-cutting campaign in September, is to induce people and businesses to boost spending.

But Bernanke and his colleagues may be running out of room to pump money into the financial markets and cut interest rates to rescue the economy.

The Fed already has committed up to 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity - that is, cash - to the financial system and opened the door to more with Sunday's decision to become a lender of last resort for the biggest Wall Street dealers.

"They're using up their ammunition on the liquidity and overnight interest-rate fronts," said Lou Crandall, chief economist at Wrightson ICAP L.L.C. in Jersey City, N.J., a large broker for banks and other financial institutions.

With that in mind, the Fed has taken a series of other unconventional maneuvers to deal with those problems and to restore confidence.

For example, in a bold action Sunday, it agreed for the first time to let big investment houses get emergency loans directly from the central bank. Also Sunday, the Fed approved a $30 billion credit line to engineer the takeover of Bear Stearns.

But 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."

Treasury Secretary Paulson countered that government intervention was necessary. "Bear Stearns had liquidity crisis, and so we felt it was very important that this be resolved as a way to minimize the impact on our economy," he said. "This is the right outcome."

The Federal Reserve last summer began trying to relieve the crisis in mortgages and the broader credit market.

Aug. 17, 2007: It lowered the discount rate for banks to borrow from the Fed by half a percentage point, to 5.75 percent.

Sept. 18 to Jan. 30, 2008: It cut the federal funds rate, a benchmark for consumer and business loans, five times, to 3.00 percent. Another is expected today.

January-March: It began special auctions to provide one-month loans to banks - about $220 billion so far.

March 7: It said it would lend up to $100 billion to 20 large bond dealers.

Last Tuesday: It announced a $200 billion loan program for investment banks.

Friday: It guaranteed a 28-day credit line for Bear Stearns. Amount not disclosed.

Sunday: It announced a $30 billion loan to JPMorgan Chase to buy Bear Stearns; a lending program for 20 major investment banks; and a discount-rate cut to 3.25 percent from 3.50 percent.

SOURCE: Inquirer research