Markets hope likely rate cut will stem tide

The Baltimore Sun

WASHINGTON -- The Federal Reserve is poised to aggressively lower interest rates again today, perhaps by as much as 1 percentage point, as it continues its efforts to ease a major credit crunch and serve as a virtual safety net for Wall Street investment bankers.

With fear gripping Wall Street, the Fed is trying to stave off a repeat of the collapse of investment banking giant Bear Stearns Cos., which prompted an emergency rate cut Sunday and the move to help arrange a deal to sell the well-known firm to JPMorgan Chase & Co. at the rock-bottom price of $2 a share.

The central bank's policymaking arm, the Federal Open Market Committee, will decide if and how much to cut interest rates amid market expectations that its benchmark interest rate, now at 3 percent, will be dropped by one-half to 1 full percentage point.

With the economy in what some analysts say is a recession and a crisis of confidence sweeping New York's banking center and the country, David Wyss, chief economist at Standard & Poor's, predicted that the central bank would slash interest rates by a full percentage point. Since September, it has reduced interest rates by 2.25 percent.

Its aggressive rate-cutting campaign has yet to halt the credit crunch, and economists such as Brian Wesbury and Robert Stein of FT Advisors in Lisle, Ill., say the reductions have created an incentive for businesses and consumers to postpone spending, while awaiting even lower rates.

"In the long run, our economy is going to be fine," President Bush said yesterday after a meeting with his economic team dealing with financial markets. "Right now, we're dealing with a very difficult situation."

Meanwhile, the stock market edged higher yesterday after the central bank's Sunday night dramatic move. After an up-and-down day, the Dow Jones Industrials climbed 21.16 points to 11,972.25. The S&P; 500 fell 11.54 to 1,276.60.

Sen. Christopher J. Dodd, a Connecticut Democrat, chairman of the Senate Banking Committee, praised the Fed's decision and said that if it had not acted, the market could have plunged sharply, especially if Bear Stearns had been forced into bankruptcy.

But with this action, the Federal Reserve has suddenly turned itself into Wall Street's safety net, a new role that could be expensive if it doesn't succeed in easing the credit crunch and more Wall Street firms get into trouble.

"We are in uncharted waters," said Joel Naroff, a Holland, Pa., economic consultant. "The financial system looks nothing like it did 10 or 20 years ago with new financial products and the internationalization of capital flows. The Fed is facing issues that are new."

Chairman Ben S. Bernanke announced Sunday night that Wall Street's largest investment banks could borrow directly from the Fed just as commercial banks now do - and use questionable collateral, such as mortgage-backed securities, to boot.

Many critics say that the central bank is pledging to rescue Wall Street without demanding an end to excesses that contributed to today's jittery markets, creating a "moral hazard" that could lead to more excesses.

"The Federal Reserve continues to give aid to the irresponsible," said one of these, Peter Morici, a business professor at the University of Maryland, College Park. Others said the U.S. government seemed quicker to bail out Wall Street bankers than people who cannot afford their mortgages.

As it moved swiftly Sunday to bring about the sale of Bear Stearns, Wall Street's fifth-largest investment house, the Fed allowed the buyer to use Bear Stearns' mortgage-backed securities as collateral for some $30 billion in financing.

The central bank also reduced the interest rate on these loans 3.25 percent and lengthened the payback term from 30 to 90 days.

When reporters asked Treasury Secretary Henry M. Paulson Jr. whether the Fed and the administration seemed more inclined to bail out big banks than Americans facing a home foreclosure, he noted that Bear Stearns stockholders are going to lose on their investments.

Dodd said the administration should move to help homeowners facing foreclosure on their homes. He has proposed legislation that would provide government insurance to refinance troubled mortgages. "Until we help the people on Main Street, the problem on Wall Street will not be resolved," he said.

Bernanke and his Fed colleagues hoped that the Sunday decision to intervene in the Bear Stearns case would help turn the corner and ease market turmoil, where fear has persisted over whether another investment bank could be next.

John Silva, chief economist for Wachovia Securities, said, "At this point, I think it [the Fed's action] is enough." But others said another Wall Street firm could be a candidate for failure. "People are still scared," said Wyss.

The central bank has bailed out individual Wall Street firms in the past, but it went a big step forward in allowing them to borrow directly from the Fed's so-called discount window, now used by commercial banks in trouble.

Silva and Dodd said the Fed could have gotten ahead of the curve by allowing Wall Street firms to borrow from the central bank much earlier. "The question comes up: Why didn't you do this a couple of months ago?" Silva said.

Bernanke and colleagues have concluded that these Wall Street firms have become too big to fail, and so need backup assistance from the Fed when needed, said Naroff.

Barry Bosworth, an economist at the Brookings Institution, raised another question: Suppose another Wall Street firm gets into trouble over mortgage-backed securities and no one wants to buy them? Fed intervention might not be enough to save such a firm, he said.

William Neikirk writes for the Chicago Tribune.

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