Feds Do Good

Fed slashes interest rates by half a point
by William Neikirk
The Federal Reserve slashed interest rates by a half percentage point today in a bold and aggressive move to prevent the economy from sliding into a recession because of a major housing correction.
The central bank also reduced its discount rate, the interest rate charged banks for direct loans, by a similar amount in an effort to ensure that financial markets do not lock up for a lack of credit.
The stock market liked the move, with the Dow-Jones industrial average surging by more than 200 points immediately after it was announced. Some saw it as a pre-emptive strike.
In a short statement, the Fed said its 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."
It added that readings on "core" inflation, the rate of price increases excluding food and energy, "have improved modestly this year," but added that "some inflation risks remain."
The central bank dropped its "federal funds rate," which banks charge each other for short-term lending, from 5.25 percent to 4.75 percent. It was the first cut since 2003. The Fed targets the funds rate as its benchmark interest rate. All other short-term interest rates, including home equity loans rates, are tied to it.
Most analysts had been expecting a reduction of only a quarter of one percentage point, to be followed by further cuts in subsequent meetings. But the Fed, headed by Chairman Ben Bernanke, decided on a deeper cut--apparently out of concern for the danger posed by the housing correction.
"Developments in financial markets since the (Fed's) last regular meeting have increased the uncertainty surrounding the economic outlook," the central bank said. "The committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth."
The decision did not preclude further reductions later this year, particularly if this move fails to settle down financial markets that have been hurt by a credit crunch, caused chiefly by the proliferation of "sub-prime" mortgages during the housing boom.
"Given the high level of fog and the dangers of financial stress and recession, the Fed decided today to take an aggressive course by cutting both the funds rate and the discount rate by 50 basis points (one half of one percent)," said John Silva, chief economist at Wachovia Securities. "In addition, the Fed emphasized the downside risks to growth due to credit conditions."
Troubles in the housing credit market began early in this decade as loose lending practices by mortgage brokers enabled many marginally qualified Americans to buy a home. Many of the loans started with a loan interest rate, which would then be reset over a period of time.
Some two million Americans who took out adjustable rate mortgages will see their interest rates reset to a higher rate this year, and many cannot afford to pay the higher bills. Defaults and foreclosures are on the increase.
Beyond that, these mortgages have been packaged and sold as securities around the world, spreading the problems in housing to many credit markets. In particular, the ability of corporations to finance through short-term borrowings by issuing notes has been severely restricted. The constriction of credit has raised fears of a recession.