Moving to contain a widening crisis, the Federal Reserve Wednesday led a coordinated round of interest rate cuts by central banks around the world. But the moves seemed to have little immediate impact on the panic gripping the global financial system.
The bold move by the central banks was the latest tactic to try to prevent the widening collapse of credit markets from sinking the global economy. But global stock markets took yet another dive, and policymakers seem to be running low on options for fighting the crisis.
Acting weeks ahead of its regularly scheduled rate-setting meeting, the Fed cut the benchmark overnight lending rate for banks by a half-point to 1.5 percent. The Fed was joined by the European Central Bank, the Bank of England and central banks in Switzerland, Canada and Sweden — each of which also slashed key short-term rates by a half-point.
Yet London's FTSE stock index was down another 5 percent and is now down 12 percent in just the past week. U.S. stock prices seesawed through the day, and the Dow Jones industrial average ended down another 200 points.
Tokyo's Nikkei index fell 9 percent, dropping for a fifth straight session, although the market closed before the global rate cut was announced.
The rate cut, intended to make credit cheaper and more available for banks, businesses and consumers, was the latest in a series of near-daily moves to quell the financial panic.
On Tuesday, the Fed took took the unprecedented step of agreeing to buy short-term business loans called commercial paper, a key link in the credit system that larger businesses depend on to run their daily operations. On Monday, the central bank expanded to $900 billion an auction program designed to pump cash into the banking system.
And all this on top of last week's dramatic action in Washington, where President Bush signed into law a $700 billion plan to rescue the financial industry.
But the moves have yet to restore confidence to banks and investors, who continue to hoard cash rather than invest it in stocks or bonds.
"I’m sure that the Fed and everyone is disappointed that what they’ve done in the credit area hasn’t accomplished as much as they would have liked," said Robert Parry, former president of the Federal Reserve Bank of San Francisco. "But the toolbox continues to expand, and hopefully what were going to see is that it has some positive impact."
Indeed, the Fed and Treasury have used nearly every tool at their disposal and have invented new ones along the way. So far, it’s not clear that those tools are going to be adequate for the job at hand.
Treasury Secretary Hank Paulson warned Wednesday that market turmoil "will not end quickly" and said it may be several weeks before Treasury begins buying unwanted and illiquid assets from financial firms under the massive program approved by Congress last week.
"You can always argue that the situation would have been a whole lot worse, but at the same time you would have to say these facilities have not been successful in narrowing the credit spreads," said William Poole, a senior fellow at the Cato Institute and former president of the Federal Reserve Bank of St. Louis.
In a Tuesday speech to a group of economists in Washington, Fed Chairman Ben Bernanke reviewed the measures the central bank has taken since the credit markets began seizing up over a year ago. The Fed has poured hundreds of billions of dollars into the global financial system, and will soon start paying interest on the reserves banks are required to hold.
The Fed took the extraordinary step of loaning $85 billion to struggling insurance giant AIG, taking an 80 percent equity stake in the company.
Yet in the past few weeks the credit crisis, which grew out of rising defaults in the mortgage market, has taken a much more dangerous turn. Banks and investors are so fearful of parting with cash they’ve drained it from the river of capital that keeps the global economy moving ahead. Without short-terms loans, businesses, institutions and governments can’t get the money they need to smooth the ups and downs of their daily operations.
"You’re actually starting to threaten legitimate companies in their daily business activities where they have no cash for payrolls," said Diane Swonk, chief economist at Mesirow Financial.
California and Massachusetts have warned that without federal help, they will soon run out of cash.
Until the credit crisis burst into the open in August 2007, the Fed largely confined its occasional market calming moves to setting short-term interest rates and lending money to banks through its "discount window" — a quaint reference to the days when bank tellers stood behind barred windows to dispense cash. In just the past few months, the Fed has converted that window to a warehouse loading dock, offering over $1 trillion in loans to just about anyone who wants one.
"We’re getting pretty close to them saying, 'We’re going to lend to everybody,' " said Swonk. "It is unprecedented."
Established in 1913 following the panic of 1907 — which was in many ways as calamitous as the stock market Crash of 1929 — the Fed was designed as a kind of financial fire brigade and given broad powers to deal with financial crises. The Federal Reserve Act provides the central bank’s governors — "in unusual and exigent circumstances" — the power to lend to "any individual, partnership or corporation" as long as certain conditions are met. The central bank is now using that authority to create tools that have never been used — or even existed.
"That 'exigent circumstances' covers just about anything you can conceive of," said David Resler, chief economist at Nomura Securities. "So the Fed has a great deal of latitude to create new ways of handling the crisis."
The Fed isn’t alone in developing new tools for a financial crisis that has so far defied measures that have worked in the past. Congress has authorized the Treasury to spend up to $700 billion to buy up bad debts from banks in an effort to free up more cash to lend. The government is also considering suspending rules that force banks to mark down the value of mortgage-backed assets that are currently almost impossible to value.
But those measures don’t attack the immediate problem — the day-to-day fear and lack of confidence among investors and lenders.
"The market's in a state of great confusion and fear," said Robert McTeer, a fellow at the National Center For Policy Analysis and former president of the Federal Reserve Bank of Dallas. "I just don't think what's going on in the markets makes much sense at all."
Fed watchers generally agree that even though the central bank’s actions — including Wednesday's rate cut — have so far fallen short, they’re all steps in the right direction.
"It can't hurt," said McTeer. "It probably will help. It probably has already helped. But you have to measure that against what would have happened had they not done it."