The Federal Reserve gave borrowers a rate cut present for the holidays. Wall Street’s response: Bah humbug!
Fed Chairman Ben Bernanke and all but one of his colleagues agreed Tuesday to trim the central bank’s most important interest rate by one-quarter percentage point to 4.25 percent. That left the federal funds rate at a nearly two-year low. The action is aimed at preventing a housing and credit meltdown from pushing the economy into recession.
Wall Street, though, thought the Fed was being stingy and stocks took a nosedive. Some investors were hoping for a bigger, half-percentage-point cut. The Dow Jones industrials plunged 294.26 points to close at 13,432.77.
“This seems to have disappointed some on Wall Street who were looking for a little more in their Christmas stockings this year from Santa Bernanke,” said Scott Anderson, economist at Wells Fargo Economics.
The rate reduction, the third this year, was needed to energize national economic growth, Fed officials explained. The deepening housing slump is affecting the behavior of consumers and businesses alike, they said.
“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 said in a statement. The three rate cuts ordered thus far “should help promote moderate growth over time.”
The Fed left the door open to additional rate cuts; many economists predicted the Fed will be forced to continue lowering the funds rate in the coming months.
The funds rate affects many other interest rates charged to individuals and businesses and is the Fed’s most potent tool for influencing economic activity.
In response, commercial banks, including Wachovia and Wells Fargo, lowered their prime lending rate by a corresponding amount, to 7.25 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans.
The fact that the Fed’s key rate was lowered again marked an about-face for the central bank. At its previous meeting in October, Fed officials hinted that their two rate cuts probably would be sufficient to help the economy survive the housing and credit stresses. Since then, however, financial conditions have deteriorated, prompting Bernanke to signal before Tuesday’s meeting that another rate cut may be needed after all as an insurance policy against undue economic weakness.
As another bolstering move, the Fed on Tuesday also lowered its lending rates to banks by one-quarter percentage point to 4.75 percent. That was the fourth cut to the discount rate since mid-August.
“Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,” the Fed said in its statement.
Banks, financial companies and other investors who made loans to people with spotty credit or put money into securities backed by those subprime mortgages have lost billions of dollars. Investors in the U.S. and abroad have grown more wary of buying new debt, thereby aggravating the credit crunch.
Harder-to-get credit has thwarted would-be home buyers, intensifying the housing collapse. Foreclosures have soared to record highs. The number of unsold homes have piled up. Problems are expected to persist well into next year.
The 9-1 decision for a quarter-point reduction to the funds rate was opposed by Eric Rosengren, president of the Federal Reserve Bank of Boston. He preferred a bolder, half-percentage point cut.
“The Fed’s language clearly reflects a heightened degree of concern about the economic outlook,” said Carl Tannenbaum, chief economist at LaSalle Bank. “They left open the possibility of additional rate reductions,” he added. If the economy were to take a turn for the worse, another rate cut could come before the Fed’s next scheduled meeting on Jan. 29-30, Tannenbaum predicted.
The situation poses the biggest challenge yet to Bernanke, who took over the Fed in February 2006. Some analysts have questioned whether he waited too long to cut the Fed’s key rate and whether he has acted aggressively enough to soothe the nation’s economic woes.
In September, the central bank dropped the funds rate for the first time in four years. Then it was a half-point drop; on Oct. 31 came a quarter-point cut.
The rationale behind the lower rates is that they will induce consumers and businesses to boost spending, invigorating economic activity. With Tuesday’s reductions, both the funds rate and the prime rate are now at their lowest levels in nearly two years.
From July through September, the economy logged its best growth in four years. But it is expected to slow to a pace of just 1.5 percent or less over the final three months of the year as the housing collapse and credit crunch chill consumers. The odds of a recession have grown.
With growth cooling, the unemployment rate, now at a relatively low 4.7 percent, is expected to rise. Analysts expect the jobless rate to climb to 5 percent by early next year.
High oil prices could complicate the Fed’s job of trying to keep the economy expanding and inflation low.
Oil prices, which had neared $100 a barrel, have moderated. But they are still high. High energy prices are a double-edged sword. They can slow economic activity and spread inflation if they cause the prices of other goods and services to rise.
“Elevated energy and commodity prices, among other factors, may put upward pressure on inflation,” the Fed said. “Inflation risks remain,” it continued, adding that it “will continue to monitor inflation developments carefully.” Some economists believed the Fed’s decision to go with a moderate quarter-point cut was a nod to those inflation concerns.
Full text of Fed statement
The full text of the Fed's statement released with the announcement is below:
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent.
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. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.
Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. 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.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; and Kevin M. Warsh. Voting against was Eric S. Rosengren, who preferred to lower the target for the federal funds rate by 50 basis points