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Fed reduces benchmark rate to as low as zero
WASHINGTON — The Federal Reserve, urgently rewriting its playbook to fight a deepening recession, cut its benchmark interest rate to as low as zero Tuesday, a surprisingly strong step that should make it cheaper for Americans to borrow on credit cards and pay their mortgages.
Wells Fargo, Wachovia and U.S. Bancorp immediately lowered their prime lending rates from 4 percent to 3.25 percent, and other banks will probably follow suit. Economists cautioned, though, that people frightened by the economy and worried about their own jobs may not feel like taking on more debt.
The Fed's action was unprecedented in the central bank's 95-year history, and Wall Street embraced it. The Dow Jones industrials, which had been up about 120 points ahead of the Fed announcement, finished the day up nearly 360, a gain of more than 4 percent.
For the first time, the Fed created a target range for its funds rate, putting it at zero to 0.25 percent. That was a dramatic reduction from the previous rate, which was an already low 1 percent. The federal funds rate is the interest that banks charge each other for overnight loans.
The radical action underscores the breathtaking deterioration in the U.S. economy and the stability of the financial system this fall, and even since Fed policymakers last gathered in late October.
For years, cutting the funds rate had been the Fed's most potent weapon for snapping an economy out of trouble. But the recession, which economists say began a year ago, seems to be worsening despite all the steps taken so far.
The move "will go down in the annals of Fed history," declared Stephen Stanley, chief economist at RBS Greenwich Capital. "I nominate this one to be called the `Who Could Ask for Anything More?' statement. The Fed is throwing everything in its arsenal."
There was fresh evidence of the economic danger Tuesday before the Fed announcement. Housing starts for November plunged by almost 19 percent, the most in a quarter-century.
And consumer prices fell by a record 1.7 percent in November, the second straight monthly decline, raising fears the nation is in a dangerous bout of deflation _ a widespread, prolonged decline in prices that would take a bite out of personal income and corporate profits and do further damage to the already pummeled housing market. The Fed's lower rates could help prevent deflation from taking hold.
At the heart of the economic crisis are credit and financial problems that have made worried banks reluctant to lend to customers _ regardless of how cheap money has become.
At the same time, fearful Americans, watching jobs evaporate and their investments crumble, have sharply cut back on spending, including on big-ticket purchases such as homes and cars that typically require financing.
The Fed hopes lower borrowing costs will entice people and businesses to spend more, helping the economy. Citing "weak economic conditions," the Fed said it expected to keep its funds rate at "exceptionally low levels ... for some time."
The bold move on rates surprised not just Wall Street investors but also economists, most of whom were predicting the Fed would cut its funds rate in half, to 0.5 percent.
With the Fed's key rate sinking to near zero, the central bank moved into uncharted territory. Still, Fed Chairman Ben Bernanke and his colleagues insisted the central bank isn't running out of ammunition to fight the crisis.
"The Fed will employ all available tools to promote the resumption of sustainable economic growth," the Fed said.
It said, for example, that it is weighing the benefits of buying longer-term Treasury securities on the open market in substantial quantities. Doing so might lower rates on those securities and help energize the economy.
The Fed also cited a program it announced late last month to buy $600 billion in debt and mortgage-backed securities from mortgage giants Fannie Mae and Freddie Mac. That has already helped push mortgage rates down.
And early next year the Fed, in another previously announced program, plans to roll out a $200 billion program to boost the availability of auto loans, student loans, credit card loans and other lending to consumers.
The Fed's statement provided a far more gloomy assessment of the economy than the central bank made after its October meeting, citing deterioration in the labor market, consumer spending, business investment and industrial production.
"It is a reflection of an utterly desolate economic picture, which will persist for the foreseeable future," said Ian Shepherdson, chief economist at High Frequency Economics.
Even Goldman Sachs Group, reported a loss Tuesday for the first time since it went public in 1999 _ $2.3 billion for the quarter. Investors bought up stock in the company anyway.
And rates on 30-year Treasury bonds have dipped to a record low as investors look for a safe place to park their money. Yields on shorter-term Treasury bills even dipped into negative territory for a time last week.
Since the start of the recession, the economy has shed nearly 2 million jobs. Analysts predict 3 million more will be lost between now and the spring of 2010. The recession is shaping up to be the longest since the Great Depression.
President-elect Barack Obama is pushing an economic recovery plan that includes spending on big public works projects to create jobs, in addition to an economic stimulus package aimed at getting people to spend more money.
Obama met said Tuesday other branches of government should to "step up" because the Fed is "running out of the traditional ammunition" in the form of rate reductions.
For consumers, the Fed move essentially means money is now on sale. Experts predict mortgage rates will fall to 5 percent or lower and home equity loans will get cheaper. The result could be billions of additional dollars in Americans' pockets.
Even for people who have been laid off, credit card defaults will be less likely "because interest rates are at massively historical lows," said Tony Plath, a finance professor at the University of North Carolina at Charlotte.
Still, some economists say there are two problems that lower rates don't address: the reluctance of people worried about their jobs to take on more debt, even at low rates, and the unwillingness of banks to lend to some people who do want to borrow.
"When you think about someone giving you a loan, it's not just the rate, it's lenders' expectations of your ability to repay that loan," said John Silvia, chief economist at Wachovia. "This is not the environment to go speculating on making loans to people who may be unemployed in two or three weeks."
And even though gas prices have dropped and inflation has ceased to be a worry, "consumers' behavior has changed," said Scott Anderson, senior economist at Wells Fargo. "People aren't spending that windfall, they're saving it."
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December 16, 2008 06:41 PM EST |
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