Interest rates cut

Stocks take off after Fed's surprising half-point reductions

September 19, 2007|By Kevin G. Hall | Kevin G. Hall,McClatchy-Tribune

WASHINGTON -- The Federal Reserve delivered a surprisingly large half-point cut to its benchmark interest rate yesterday, sending stocks soaring even as the Fed signaled that recent financial turbulence menaces the broader economy and that recession is now a greater threat than resurgent inflation.

The rate-setting Federal Open Market Committee announced it was lowering the benchmark federal funds rate to 4.75 percent from 5.25 percent, the first such cut since June 2003.

The Dow Jones industrial average responded by recording its largest one-day jump in nearly five years.

Significantly, the Fed panel also cut the discount rate - the rate it charges banks for loans - by half a percentage point. That move, on the heels of a quarter-point cut in that rate last month, signaled to investors that the Fed might cut rates again in late October if it believes the slumping economy needs more spark. Rate cuts affect the broad economy generally after a lag of about one year.

"Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time," the FOMC statement said.

That left no doubt that Fed governors feared that the recent tumult on Wall Street and in Europe threatened the global economy.

Pointing to a protracted slowdown in U.S. housing sales, the Fed statement said problems in credit markets, where corporations issue short-term debt to raise money for day-to-day operations, have "the potential to intensify the housing correction and to restrain economic growth more generally."

Bank of America, Wachovia and several other large banks followed the Fed's lead and cut their prime lending rates, which they charge their best borrowers, from 8.25 percent to 7.75 percent. That will make it cheaper for borrowers with good credit histories to take out car loans and home equity loans. It also will lower payments on some adjustable-rate mortgages and some variable-rate credit cards.

Yesterday's rate cuts also will lower the cost of borrowing for businesses.

"Our guys will like it, but general business at this time wasn't calling for the rate cut," said Martin Regalia, chief economist for the U.S. Chamber of Commerce.

The rate cuts could spur more business investment, as companies that were unsure about the economy's direction may take the Fed's action as a sign that growth will pick up again as borrowing costs fall.

For all the salutary effects from the Fed's action, they won't end deep problems in the housing sector.

Foreclosures up

RealtyTrac Inc., a real estate research firm, reported yesterday that the number of U.S. foreclosure filings more than doubled in August over that month in 2006 and jumped 36 percent from July.

Those grim housing statistics reflect the first wave of adjustable-rate subprime mortgages, issued to borrowers with weak credit, that are adjusting to higher rates, which many homeowners can't afford. As many as 2 million such adjustments are expected by the end of 2008.

The FOMC's unanimous move suggests that Fed Chairman Ben S. Bernanke, viewed as an inflation hawk, sees inflation threats ebbing. Yesterday's action came on the same day that the Labor Department reported that wholesale inflation, affecting producers, fell 1.4 percent in August after rising 0.6 percent in July.

The inflation outlook could worsen, however, if oil prices remain high. Crude oil closed at a nominal record of $81.51 a barrel yesterday, rising 94 cents, or 1.2 percent, on the New York Mercantile Exchange. Oil traders fear that rate cuts could boost the U.S. economy and thus raise demand for oil at a time of increasingly tight global supply.

After the Fed's move, the price of gold - a classic hedge against inflation - surged to its highest point since 1980 before falling back to close down 10 cents at $723.70.

The nation's manufacturers cheered the Fed move.

`A great surprise'

"With banks already starting to tighten credit on commercial and industrial loans, it is clear that the effects of the turmoil in the subprime lending market have started to spread," said David Huether, chief economist for the National Association of Manufacturers. "Today's action by the Federal Reserve should mitigate the impact of the housing downturn on other components of the economy."

Wall Street was thrilled.

"This comes as a great surprise because the Fed's doing everything anyone would have hoped for in their wildest dreams, which is opening the door for a declining-rates cycle," said Robbert Van Batenburg, head of research for Louis Capital Markets, a brokerage that specializes in mergers and buyouts. "Something out there must have given the Fed real reason for concern."

That "something" may have been an old-fashioned bank run by depositors at Northern Rock, a large British mortgage lender. The British government promised late Monday to fully guarantee all deposits at Northern Rock, but that didn't stop depositors from lining up to withdraw their savings.

Although there haven't been bank runs lately in the United States, there has been what economists are calling a "non-bank bank run." Investors have been reluctant to purchase commercial paper, the short-term debt issued by corporations, and this tightening in credit markets is deemed akin to depositors yanking their cash from bank vaults.

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