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Fed Rate Cut Eases Stock Market Panic

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By EDMUND L. ANDREWS, The New York Times

Published: January 23, 2008

Updated: 01/23/2008 12:24 am

WASHINGTON - The Federal Reserve, confronted by deepening panic in global financial markets about a possible recession in the United States, struck back on Tuesday with the biggest one-day reduction of interest rates on record and at least temporarily stopped a vertigo-inducing plunge in stock prices.

The unexpected decision came after a rare, hastily called policy meeting by video conference on Monday evening, and it reduced the Fed's benchmark overnight lending rate by three-quarters of a percent to 3.5 percent.

The Fed's move was prompted in part by turmoil in global markets on Monday, a holiday in the United States. Shortly after lunch that day, Fed Chairman Ben Bernanke canceled a planned trip to New York and started organizing the impromptu meeting of Fed officials who decide interest rate policy.

Treasury Secretary Henry Paulson, watching the same market turmoil, was sufficiently anxious that he called President Bush at the White House.

In a statement accompanying the Fed's decision, which was announced about an hour before the stock market opened for trading, officials hinted that they may well reduce rates yet again at their scheduled meeting next week.

The magnitude of the Fed's rate cut helped reverse what began as a horrendous day in the stock markets. European and Asian stock prices plunged for the second day in a row, and the Dow Jones industrial average fell 464 points - about 5 percent - as soon as markets opened in New York.

By the close of trading Tuesday afternoon, stock prices, after gyrating wildly for hours, had clawed much of their way back. Shares of banks and insurers of mortgage-backed securities, which had been battered in recent days, were among the day's biggest gainers.

"Wall Street is incredibly jittery," said Len Blum, a partner at Westwood Capital, a boutique investment bank in New York. "They don't know how to react to it. The last time they did a rate cut in between meetings was after Sept. 11, 2001."

The Fed's move came as Bush and congressional leaders pledged to work together on a bipartisan fiscal measure to jolt the economy with about $145 billion in tax rebates, tax breaks for businesses and possibly additional payments to low-income people.

"I believe we can find common ground to get something done that's big enough and effective enough," Bush said. Sen. Harry Reid, the Senate majority leader, said he hoped Congress could pass a bill before the Presidents Day recess on Feb. 18.

Still, it was a nerve-wracking day on Wall Street, with the Dow ending down 128 points, or about 1 percent. Even after the rebound, the major market indexes are down about 10 percent so far in January and even further off their recent highs in October. The Nasdaq composite index, which mostly reflects technology stocks, is off 18.3 percent.

Economists said it remained far from clear that the United States will avoid a recession, either because the Fed and the Bush administration had moved too slowly or because the economy's woes were too acute to solve so quickly and painlessly.

"This is unique in the modern history of the Fed," said Vincent Reinhart, a resident scholar at the American Enterprise Institute who was director of the Fed's division of monetary affairs from 2001 to 2007.

Even so, it may not be enough to head off a downturn in the economy: Changes in interest rates usually work with a lag time of at least six to nine months, and many economists say that it may have begun.

Citigroup, citing the severely depressed housing market, the credit crunch and high energy prices, predicted on Tuesday that the economy was about to start shrinking and would barely eke out any growth for all of 2008.

"Academic definitions aside, we'll call that a recession," wrote Steven Weiting, a Citigroup economist.
Fed officials stopped well short of such gloom and doom, but they made it clear they had been alarmed by both worsening data in the United States and the worldwide stock panic that began Monday.

"Broader financial market conditions have continued to deteriorate," the central bank said, noting that the credit crunch has continued to tighten for many businesses and households, the housing market continues to spiral downward and job creation has slowed.

"Appreciable downside risks to growth remain," the central bank said, its most forceful acknowledgment yet that the U.S. economy is on the brink of a recession as a result of a perfect storm of the severe downturn in housing, the fallout from soured mortgages and the added blow of high oil prices.

The move represented a dramatic shift for Bernanke, who took over as Fed chairman two years ago. Bernanke, a former professor of economics at Princeton, had resisted calls for a big rescue effort by the Fed and favored a less personalized approach to monetary policy than his predecessor, Alan Greenspan.

This was also the central bank's biggest one-day cut in the federal funds rate, which is its target for the overnight rate at which banks lend their reserves to each other. Fed officials clearly hoped that a bold and decisive act would calm investors and restore confidence in credit markets, where fears about soaring defaults on subprime mortgages have increasingly forced banks to curtail their lending in other areas.

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