Fed pumps in cash

Step eases air of panic in jumpy week on Wall Street

August 11, 2007|By William Neikirk | William Neikirk,Chicago Tribune

WASHINGTON -- The Federal Reserve flooded nervous financial markets with three big injections of cash yesterday to head off concerns that a spreading credit crunch could cause a Wall Street meltdown.

The central bank's emergency action appeared to stem a panic atmosphere that had gripped the stock market earlier in the day, but volatile trading for most of the day gave little confidence that the medicine would be long-lasting.

The Dow Jones industrial average ended down by 31.14 points, and the Standard & Poor's 500 index managed a gain of 0.55 of a point. At one point in the day, before the Fed had completed all its money injections, the Dow Jones average had fallen 212 points.

Yesterday's session capped a tumultuous week on Wall Street. The Dow gained nearly 154 points Wednesday, then plunged 387 points Thursday - its largest one-day loss since February - continuing a pattern of triple-digit gyrations since the index closed at a record high of 14,000.41 on July 19.

For the week, the Dow was up 0.44 percent, the S&P 500 rose 1.44 percent and the Nasdaq was up 1.34 percent.

With the closing bell yesterday, attention turned to next week to see whether the Fed will continue to pump even more money or "liquidity" into the markets or whether it will have to consider an interest-rate reduction. Odds of an interest cut at its September meeting increased, with some analysts saying that a cut could come sooner.

The central bank acted in the wake of signs that problems in the subprime mortgage market for riskier loans had begun to spread to other sectors, and even reached overseas. Holders of some mortgage-backed securities have seen losses mounting and housing financing has become more difficult.

Announcing that it is "providing liquidity to facilitate the orderly functioning of financial markets," Chairman Ben S. Bernanke's central bank pumped a total of $38 billion into credit markets yesterday on top of $24 billion a day earlier. It was reminiscent of the Fed's emergency cash infusion after the Sept. 11, 2001, terrorist attacks.

It had little choice but to do so. The interest rate that it seeks to control, the "federal funds" rate on short-term loans between banks, had jumped to nearly 6 percent yesterday because of tightening credit, even though the Fed has vowed to keep that rate at 5.25 percent.

It took three injections of cash into financial institutions to accomplish that goal. And there could be more: The Fed said it will "provide reserves as necessary" to keep the rate at 5.25 percent in the future.

"The first thing it has to do is maintain orderly markets," said David Wyss, chief economist at Standard & Poor's, the credit-rating firm. "If it doesn't, it loses all control."

President Bush had no comment, but spokeswoman Dana Perino in Kennebunkport, Maine, where Bush is vacationing, said his advisers "are keeping a very close eye on all market activity."

In Washington, Treasury Secretary Henry M. Paulson Jr. spent the day in what his aides said was constant, hourly contact with the Fed, other officials in the administration, finance ministries and regulators overseas and people on Wall Street.

"We've been in touch with our colleagues in other agencies and among the financial regulators and are monitoring the situation carefully," said Michele Davis, the Treasury spokeswoman. "Beyond that, we are not commenting."

Opinion was divided on whether the central bank's action will do much good, with many economists taking a wait-and-see attitude.

To some, reducing interest rates further would essentially rescue those who engaged in unwise credit practices, and a bailout is something that the Fed has long sought to avoid. Still, some analysts said the Fed's action smacked of a stock-market bailout.

The Bernanke Fed has shown more concern about inflation than economic growth and appears to be "more of an academic Fed and less pro-active" than that of former Chairman Alan Greenspan, said Diane Swonk of Mesirow Financial in Chicago.

There aren't many options for the central bank. Only Tuesday, the Fed had shrugged off problems in the credit markets and decided to hold interest rates steady. To back off that statement and cut rates quickly could damage the Fed's credibility, said economic consultant Joel Naroff.

The central bank could have taken its chances and not acted so swiftly with such a big infusion, but that would have been risky, especially since markets in Europe had swooned a day earlier after a French bank's problems with mortgage-backed securities.

Angelo Mozilo, chief executive of Countrywide Financial Corp., the biggest U.S. mortgage lender, told Bloomberg News he was optimistic. "The action of the Fed [yesterday] may change everything," he said. "It certainly provides liquidity to the banks. I feel very positive about the move."

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