Fed’s Action Stems Sell-Off in World Markets

EDMUND L. ANDREWS
NYT, January 23

WASHINGTON — The Federal Reserve, confronted by deepening panic in global financial markets about a possible recession in the United States, struck back on Tuesday morning 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 videoconference on Monday evening, and it reduced the Fed’s benchmark overnight lending rate by three-quarters of a percentage point, 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, the Fed chairman, Ben S. Bernanke, canceled a planned trip to New York and started organizing the impromptu meeting of the Fed officials who decide interest rate policy. The Treasury secretary, Henry M. Paulson Jr., watching the same market turmoil, was anxious enough 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 might reduce rates yet again at their scheduled meeting next Tuesday and Wednesday.

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 had already plunged for the second consecutive day, 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, stock prices, after gyrating wildly, 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. Asian markets seemed to calm Wednesday morning with most exchanges opening higher.

“Wall Street is incredibly jittery,” said Len Blum, a partner at Westwood Capital, an 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 Mr. Bush and Congressional leaders pledged to work together on a bipartisan 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,” Mr. Bush told reporters. Senator Harry Reid of Nevada, the Senate majority leader, said he hoped Congress could pass a bill before the recess for Washington’s Birthday on Feb. 18.

Still, it was a nerve-racking 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 would 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 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: changes in interest rates usually work with a lag time of at least six to nine months, and many economists say that a recession may already have begun.

Citigroup, citing the severely depressed housing market, the credit squeeze 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 Wieting, 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 on Monday.

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

“Appreciable downside risks to growth remain,” the central bank said, its most forceful acknowledgment yet that the United States economy is on the brink of a recession as a result of the triple punch from 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 Mr. Bernanke, who took over as Fed chairman two years ago. Mr. 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.

But when Mr. Bernanke called policy makers together for an emergency meeting on Monday night, with regional Fed presidents participating over secure videoconference lines, he embarked on the boldest policy move in years.

This was only the fifth time that the Federal Reserve had reduced the overnight federal funds rate outside of its regularly scheduled policy meetings. It did so in October 1998, during Russia’s financial collapse, two more times in early 2001 as the economy was sliding into a recession and once more after the terrorist attacks on Sept. 11, 2001.

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. Until Tuesday’s reduction of three-quarters of a percentage point, the biggest individual cuts were by half a point.

The only comparable rate cuts were in 1982 and 1984, when the central bank, which was following different procedures, reduced the overnight rate by more than one percentage point over the span of several weeks.

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.

But while investors did react with relief, the Fed’s move also seemed to validate the fears that the economy is closer to a recession than policy makers had thought.

On Wall Street, many if not most analysts had assumed that the central bank would reduce overnight rates by half a percentage point at the next policy meeting. But with the meeting only one week away, few investors expected the Fed to cut rates before then — a move that could easily be seen as panicky behavior.

The Fed move carries other risks. Reducing the interest rate could push up the inflation rate, even as it bolsters consumer spending.

In a speech this month, Mr. Bernanke strongly hinted that the Fed would reduce rates again at the policy meeting scheduled for next week. Mr. Bernanke had clearly not expected to move before the meeting.

But the Fed chairman became notably more worried by late last week. Most of the incoming economic data pointed toward a slowdown. On top of rising unemployment in December and depressed holiday sales at many major retailers, there were signs of a worsening credit squeeze, new declines in housing starts and worries about the companies that insure mortgage-backed securities.

Mr. Bernanke and other Fed officials contend they do not make decisions in order to calm financial markets. But analysts say they became alarmed about last week’s stock market plunge and Mr. Bernanke was even more alarmed by the huge drops Monday in foreign stock markets like Frankfurt, London and Hong Kong.

The drop in foreign stock prices undermined one of the last bright spots for the American economy — the prospect that a strong global economy, combined with a cheap American dollar, would spur enough export growth to offset a weakness at home.

The growing sense of crisis added urgency to efforts by Mr. Bush and Congressional leaders to bury their political animosities and agree on a short-term fiscal- stimulus package.

A spokesman for Mr. Paulson said that he had been busy reaching out to Congressional leaders all last week and that the market declines of the last few days had not by themselves forced him to quicken the pace.

Mr. Bush and Congressional leaders have both talked about a package that would inject about $150 billion in additional money into the economy. That would equal about 1 percent of the nation’s economic output, which economists and Fed officials said could make a difference if the money gets into people’s hands quickly enough.

But even if Congress passes such a measure by mid-February, which would require Republicans and Democrats to suppress their animosities and their contrasting economic approaches, the earliest that tax rebates would actually reach people would probably be this summer. At that point, it would help soften the blow but a recession might have already been under way for months.

Ultimately, it is the Federal Reserve that has the most power to avert or soften a recession. But its power is finite, and its primary tool — lower interest rates — takes time to work.

“Monetary policy works with a lag,” said Mr. Reinhart, the former top Fed official. “There’s nothing the Fed can do to prevent a recession if it is coming in the first half of this year.”

Steven R. Weisman and Carl Hulse contributed reporting.