The Federal Reserve took another bold step to boost troubled credit markets Tuesday as Chairman Ben Bernanke hinted at another interest-rate cut to spark the U.S. economy.
Wall Street was unmoved. All three major American stock indices lost another 5percent of their value.
The Dow Jones industrial average fell 508.39 points, or 5.1 percent, to close at 9447.11. The S&P 500 was off 60.66, or 5.7 percent, to 996.23. The Nasdaq finished down 108.08 points, or 5.8 percent, to 1754.88.
The Dow is down 13 percent in the past five trading days. Tuesday's close was its lowest close in five years, since Sept. 30, 2003.
Speaking to business leaders in Virginia, President Bush said his administration is moving at a breakneck pace to implement a bank rescue plan passed last week by Congress. He urged companies to stay positive and take a “we can do it” attitude.
Bernanke widened the Fed's emergency lending programs Tuesday morning. He then hinted in a lunch speech that more interest-rate cuts to spark the economy are coming – perhaps late this week at a meeting in Washington of the Group of Seven's finance ministers – or perhaps when the Fed's policymakers meet Oct. 28-29.
“In view of the intensifying international dimension to the crisis, it would not be a surprise if a coordinated rate move were announced at G-7 meetings on Friday in Washington,” said Peter Kretzmer, an economist with Bank of America, in a research note to investors that predicted a half-point cut from the current 2 percent to 1.5 percent.
Citing an easing of inflation threats and clear signs of a sharp slowdown in economic activity, Bernanke told the National Association for Business Economics that the Fed “will need to consider whether the current stance of policy seems appropriate.”
Cutting the Fed's benchmark lending rate might lower borrowing costs for consumers and business, but the problem isn't high rates; rather, it's the fact that banks can't or won't lend, and fear reigns in the world of finance.
To address the loss in confidence among lenders, Bernanke moved before markets opened Tuesday to announce the Fed would start buying the short-term debt issued by major domestic and foreign corporations based in America.
The decision puts the Fed into another area traditionally outside its domain, backstopping corporations outside the banking sector. The action was spurred by the largest monthly drop ever, $153.5 billion in September, in a market once considered among the safest investments.
Big U.S. corporations such as General Electric, Caterpillar and other multinational companies issue commercial paper to raise money to pay for their inventory and cover payroll. This paper, as it's known, is a 30-day promissory note that works like an IOU. Until recently, such notes were snapped up by banks and money market funds. But as the global credit crisis widened, banks weren't willing to invest in commercial paper, preferring to ride out the growing financial storm by sitting on cash instead of lending it. In the last three weeks, the commercial-paper market has shrunk by more than $200 billion.
So, using its authority as the lender of last resort, the Fed said it would buy commercial paper through April 30, 2009. The action was open-ended, meaning it will be based on demand and without a fixed price tag on it.
“The Federal Reserve's move should go a long way toward unlocking the commercial-paper market. It had become too clear the strategy of providing reserves to banks with the hope those banks would lend to each other and to corporate borrowers had failed,” said Howard Simons, an investment strategist for Bianco Research in Chicago. “The Federal Reserve, by lending directly, has removed the very real possibility that large high-quality corporate borrowers might have had to close down operations for lack of short-term liquidity.”
In his lunch speech, Bernanke defended a long string of aggressive Fed moves as necessary given “a problem of historic dimensions” and because delay would only make things worse.
“We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased,” he said.