The Federal Reserve rushed to the rescue of a shaky stock market Tuesday with its biggest interest-rate cut in more than two decades, leaving investors expecting more help from their new best friend in Washington.
Faced with lagging credibility in financial markets, Chairman Ben Bernanke flexed the Fed’s monetary muscle even as President Bush and congressional leaders were preparing legislation aimed at pumping $140 billion or more into an anemic economy.
The goal: to jolt the system back on track.
The Dow Jones industrial average staged a partial recovery from a nearly 465-point drop Tuesday morning but still finished lower for a fifth straight day amid worries the three-quarter-point cut in the Fed’s benchmark lending rate comes too late to avert a recession.
Fed policymakers, who weren’t scheduled to meet until next week, said they took the emergency action due to “a weakening of the economic outlook and increasing downside risks to growth.”
After months of measured responses to the mortgage-lending crisis and slowing economy, the sudden move by Bernanke’s Fed “sends the signal that conditions are much worse than anyone anticipated,” said Richard Yamarone, director of economic research at Argus Research. “I’m in shock at how the Bernanke Fed went from an easing stance to an outright rate-slashing festival.”
Another cut is likely when the Fed meets Jan. 29-30, analysts predicted.
“If the market does poorly, the Fed will move more aggressively,” said Robert Dederick, principal at the RGD Economics consulting firm. “The Fed is going to do all it can to avoid a prolonged business setback.”
After plunging shortly after it opened, the Dow recouped the bulk of its losses to close down 128.11, at 11,971.19, its first close below 12,000 since 2006. The S&P 500 capped its longest losing streak in almost a year, retreating 14.69, to 1310.50. The Nasdaq composite index lost 47.75, to close at 2292.27.
Not since the Sept. 11, 2001, attacks has the government faced this kind of gathering economic storm.
President Bush, who had come to power advocating tax cuts, had succeeded in pushing them through Congress before the terrorist attacks delivered a severe blow to the economy. The U.S. escaped with a shallow recession.
“It turned out to be the best-timed fiscal intervention in history,” said Barry Bosworth, economist at the Brookings Institution.
No one knows how fast Congress can get a stimulus package to the president’s desk this time. In a meeting with congressional leaders, Bush said Tuesday that “everybody wants to get something done quickly, but we want to make sure it gets done right.”
The package is expected to include tax rebates, but one major dispute is whether money also should go to low-income Americans who now pay no taxes. Democrats want such a plan; Bush does not.
Economists say that a “temporary, targeted and timely” tax-cut bill sought by Bush will be hard to achieve in a presidential election year.
“What is driving the fiscal policy is much more politics than economics,” said David Resler, chief economist at Nomura Securities International.
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By contrast, the central bank can act without political considerations and take back rate cuts when needed. Lower interest rates have a powerful economic punch across the economy, reducing the rate on many short-term loans, including home-equity loans, and providing more reserves to banks so they can lend more money.
Even with such dramatic steps, questions linger about whether they will address the credit crunch triggered by the subprime-mortgage market that has hurt banks and investors around the world.
Analysts said most of the new money pumped into the economy by interest-rate cuts and tax reductions only marginally help to deal with the problem. But it could buy time, staving off a deterioration of the economic climate so that banks can work out their financial problems.
One irony is that evidence of an impending recession in recent economic data is slim, indeed, according to Brookings’ Bosworth, though some analysts have warned the U.S. faces a deep downturn, perhaps as deep as the recession in the early 1980s.
The Fed appeared to be responding Tuesday to new information, possibly an economic activity index calculated by the Federal Reserve Bank of Chicago that hit its lowest level in more than four years in December, dragged down by a sharp contraction in employment-related indicators.
Argus’ Yamarone speculated that policymakers moved aggressively Tuesday because of fresh worries about a crisis at a big financial institution.
“There may be a bank in trouble, a mortgage lender, an insurer. There’s something looming. That’s what makes this so scary,” he said. “Somebody apparently went a’knockin to the Fed after Bernanke’s testimony last Thursday and said, ‘We’ve got a critical disease and we’ve slept with the world.'”
The Fed’s rate-cut announcement, just 90 minutes before the market opened Tuesday, came on the heels of sharp retreats in global stock markets.