NYT : Fed Cuts Key Interest Rate by a Half Point

Fed Cuts Key Interest Rate by a Half Point

By EDMUND L. ANDREWS and JEREMY W. PETERS | September 18, 2007

WASHINGTON, Sept. 18 — The Federal Reserve today lowered its benchmark interest rate by a half point, a forceful policy shift intended to limit the damage to the economy from the recent disorder in the housing and credit markets.

While an interest rate cut was widely expected, it had been uncertain whether the Fed would opt for a half-point or a quarter-point reduction. The decision, which reset the overnight lending rate to 4.75 percent, was unanimous.

In a statement announcing its decision, the Fed left open the possibility of another cut in the weeks ahead if the economic outlook deteriorates further. It said it will “will act as needed to foster price stability and sustainable economic growth.”

The statement’s emphasis on the uncertain outlook indicates that the Fed now believes a slowdown in growth — not high inflation — is the biggest risk to the economy.

Many on Wall Street had been clamoring for weeks for a half-point cut, and the Fed’s announcement today buoyed investors.

Stocks immediately soared. The Dow Jones industrial average had been up about 75 points shortly before the announcement at 2:15 p.m., and within seconds it jumped another 100 points. At 2:45 p.m., it was showing a gain of 250 points on the day, or almost 2 percent.

For consumers, the Fed’s move could mean lower borrowing costs on major loans like mortgages, home equity credit lines and auto loans.

In a separate move to bolster the banking system, the Fed also said today that it cut its discount lending rate, which applies to short-term emergency loans to banks, to 5.25 percent — also a half-point cut.

This was the Federal Reserve’s first rate cut in four years, and its most abrupt reversal of course since January 2001, when it suddenly slashed rates at an unscheduled emergency meeting because of signs that the economy was slipping into a recession.

As recently as six weeks ago, the central bank was still predicting “modest” growth for the economy and warning that inflation remained its “predominant concern.” As in 2001, the Fed’s move today came after a panic in financial markets and the collapse of a speculative bubble. This time, the panic is in credit markets spooked by dubious mortgages on inflated housing prices. Back then, it was the stock market that crashed, initially because the air went out of inflated dot-com stocks.

In the jargon of economists, the turmoil in both cases represented a sudden “repricing” of risk. Other signs have surfaced recently that the financial market upheaval may not be isolated. Earlier this month, the Labor Department reported the first monthly loss of jobs in four years. Employers eliminated 4,000 positions in August, a factor that may have played a role in the Fed’s decision today.

By today, it seemed clear that Fed policy makers were no longer debating whether to reduce rates but how much to lower them. Despite the seemingly narrow debate — whether to lower the overnight federal funds rate by one-quarter of a percent or by one-half of a percent — the uncertainty about this policy meeting was higher than any other in the past four years.

The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.

Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.

But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.

Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.

The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.

Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.

But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.

Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.

The Labor Department also reported today that producer prices fell by 1.4 percent in August — much more than expected — because of slumping energy prices. That was positive news on inflation, but analysts said it was unlikely to have much influence on the Fed because the "core” measure excluding energy and food prices increased 0.2 percent, slightly more than expected.

Except for the housing downturn, which Fed officials admit is much more severe than they had expected, the evidence of a recession in the real economy is ambiguous. Global economic growth is much stronger than in 2001, and American exports have climbed about 14 percent over the last year.

Instead of the United States’ being the world’s engine of growth, the global economy could now become the engine of American growth.

For the last four years, the Federal Reserve has telegraphed its intentions months in advance as it pursued a gradualist approach of slow but steady adjustments in monetary policy. It advertised its intention to raise rates gradually many months before it actually did so in June 2004, and then raised rates in well-signaled increments at each policy meeting over the next two years.

By contrast, Wall Street analysts were sharply divided as of early today about how much the Fed would cut rates and what it would say in its statement about the economic outlook.

A smaller rate reduction posed a risk of moving too slowly if the economy was indeed in danger of stalling. But a bigger rate reduction could have been taken as a sign of Fed panic, and it added to the risk of stoking inflationary pressures that the central bank had just begun to tamp down.

But the evidence so far is inconclusive. In August, for the first time in four years, the Labor Department estimated that the number of jobs declined slightly. It also reduced its estimates of job growth in June and July, suggesting that the labor market weakened even before credit markets froze up in early August.

But other indicators — on consumer spending, consumer confidence and export growth — point to a continuation of modest growth.

Right or wrong, today’s decision will be a defining moment for Mr. Bernanke, the former economics scholar at Princeton who became Fed chairman in February 2006.

Many Wall Street economists place the odds of a recession at about one in three or somewhat higher. Alan Greenspan, who preceded Mr. Bernanke as Fed chairman, puts the odds at somewhat more than the one-in-three that he estimated earlier this year.

The Fed’s course change has been under way since early August, when fears about huge losses on subprime mortgage loans and continued downturn in housing caused a much broader panic in credit markets.

The resulting credit crunch has now affected all but the safest home mortgages, and also greatly reduced the ability of private equity funds and hedge funds to borrow money at low rates. Many banks, which had been planning to resell their loans into the giant market for tradable commercial debt securities, are now being forced to absorb loans that the securities markets will no longer take.

On Aug. 17, the Federal Reserve moved to ease the liquidity crisis by encouraging banks to borrow money through its “discount window,” a program originally created as an emergency source of overnight funds for banks in a cash squeeze.

But by most accounts, the turmoil in credit markets has abated very little. The market for subprime mortgages has all but disappeared, and demand for all forms of “asset-backed commercial paper,” which are securities backed by mortgages, credit card debt, company receivables, remains very weak.

Vikas Bajaj contributed reporting from New York.