Fed Rate Cut Boosts Stocks; Another Cut Coming?
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Yesterday's stock market gains could be a sign of recovery, or they could just be a brief break in a long run of bad news. Either way, in a single day, stock owners got back some of the value they've lost in recent months. Standard & Poor's broad index of major stocks was up more than four percent. Prices jumped in part because the Federal Reserve cut a key lending rate.
The Fed suggested yet another rate cut could be coming, and that's just one part of an unorthodox effort to hold back a market panic. NPR's Jim Zarroli reports.
JIM ZARROLI: The Fed painted a gloomy picture of the economy. It said the labor market has softened, consumer spending has slowed, credit conditions have tightened and financial markets are stressed. To keep the economy from weakening any further, it said it was cutting the federal funds rate by three-quarters of a percentage point, or 75 basis points.
That was less than some investors had hoped for, but still high by historic standards. Stuart Hoffman is chief economist at PNC Financial Services Group.
Mr. STUART HOFFMAN (Chief Economist, PNC Financial Services Group): I think with the Fed still mostly focused on the economy, but looking inflation at of the corner of its eye, I think they decided that let's go with a somewhat compromised 75-basis-point rate cut, leave the door open for a further rate cut, maybe next month.
ZARROLI: That policymakers did express concern about inflation pressures and two members dissented, saying they favored a less aggressive move. But the Fed made clear it's ready to err on the side of doing too much rather than too little. Over the past two weeks, the Fed has kicked into high gear. It engineered the acquisition of Bear Stearns at a fire sale price by JPMorgan Chase, an acquisition backed by federal money.
The Fed also said it would allow banks and other financial institutions to buy Treasury bills using their bad mortgage debt as collateral. That lets them improve their balance sheets by trading bad debt for good. Economist Dean Baker says that presents something of a risk to the Fed.
Mr. DEAN BAKER (Economist): If any of them actually are in bad shape and are enable to repay the loans, then the collateral is likely not going to be equal to the full value of the loans.
ZARROLI: And when one of the borrowers defaults, the public indirectly foots the bill. Baker points out that under the terms announced by the Fed, the public won't know which banks take advantage of the lending program.
Mr. BAKER: I'd like to see those be public. If there's a stigma attached, well, that's the way it goes. You know, people should know if Citigroup or one of the other big banks is relying on the Fed in a very big way to borrow reserves. We should know that.
ZARROLI: The Fed also decided to extend credit to so-called non-depository institutions, like brokerage houses and investment banks. Unlike banks, which are regularly audited by the Fed, these other firms aren't tightly regulated by the U.S. government. So it can be tough for the public to know the extent of the liabilities the Fed is taking on.
But Baker says the Fed does deserve some credit for stabilizing the financial markets this week.
Former Fed economist Anne Owen, a professor at Hamilton College, says there are risks to the Fed's decision to extend borrowing to so many Wall Street firms. If too many defaults take place and the Fed goes through its reserves, it would have to print money, which is highly inflationary. But Owen says that's unlikely, and she says it's a risk the Fed has to take.
Professor ANNE OWEN (Economist, Hamilton College): In the long run, this is something that you would not want to see occurring. But, again, I think the Fed is in a tough position. They have to do something because the short-term consequences of them not doing something could be very bad.
ZARROLI: Owen says the unprecedented nature of the current crisis means the Fed has to do what it takes to keep the economy going. That means using traditional methods, like rate cuts. But increasingly, it also means trying less orthodox measures.
Jim Zarroli, NPR News, New York. Transcript provided by NPR, Copyright NPR.