Market declines come as U.S. sets loans for businesses, weighs rate cut

WASHINGTON — The world's leading economic policymakers Tuesday took major actions to try to stabilize financial markets — and suggested that more measures were on the way.

Hours after the Federal Reserve for the first time said it would lend up to $1.3-trillion directly to businesses that aren't banks, Chairman Ben Bernanke signaled that the central bank may soon cut interest rates. Meanwhile, the British government was preparing an emergency plan that could inject tens of billions of dollars into its banks. The European Union raised its protections on bank savings, and EU finance ministers pledged to better coordinate their response to the financial crisis.

Markets were hardly assuaged, especially in the United States.

The Dow Jones Industrial Average declined for a fifth consecutive day, falling 508 points, or 5.1 percent. The Standard & Poor's 500-stock index dropped 60.66, or 5.7 percent; it is down 15 percent this month. European markets were flat on the news of the savings guarantees.

The Dow extended a monthslong slide that has erased a third of its value in a year. In the last five trading days alone, the Dow has lost 1,400 points.

With the flow of credit still tight, investors have fixated on the threat of a serious recession despite the increasingly urgent attempts by policymakers to buttress the markets. Deepening problems in the European banking industry have compounded fears of a worldwide downturn.

"The Fed is just plugging holes in the dam and the water keeps rushing over," said Michael Darda, chief economist at the research firm MKM Partners.

The U.S. declines followed a gloomy assessment from Bernanke, who said in a speech Tuesday that the deepening financial crisis had darkened the country's economic outlook. Investors were also concerned that banks and real estate companies are in even more trouble than had been thought, following the announcement late Monday that Bank of America will chop its dividend.

Separately Tuesday, the rate that banks charge for loans to each other, a crucial measure of the flow of credit, rose.

Short-term debt

The troubling signs came despite a morning announcement that the Fed will buy up commercial paper, the short-term debt that funds the daily operations of banks and ordinary businesses. In a bold new attempt to jump-start the lending that is the lifeblood of American business, the central bank said it would create a special entity to purchase this short-term debt.

The investors who normally snap up those relatively low-risk investments, such as college endowments and money market mutual funds, aren't doing so. That is causing pressures throughout the financial system that are damaging the overall economy. So the Fed has moved to essentially funnel cash to companies — up to the entire $1.3-trillion of high-quality commercial paper that has been issued.

"The central bank is finally starting to get aggressive," said Drew Matus, a senior economist at Merrill Lynch. "Now they're trying to keep things functioning until the Treasury plan starts up," he said, referring to the $700-billion fund to buy up troubled assets from financial firms.

Tuesday's action by the Fed could even lay the groundwork for future interventions in credit markets, should the troubles deepen.

"It could be expanded for different types of securities," said Michael Feroli, a U.S. economist at J.P. Morgan Chase. "Today Bernanke said they're going to continue to be aggressive and innovative, and I don't expect that to slow down any time soon."

In his speech Tuesday afternoon, Bernanke indicated that the Fed could cut interest rates soon to try to shield the economy against the fallout from the financial crisis. Prices in futures markets indicate that investors are nearly certain rates will be cut at the Fed's Oct. 28-29 policymaking meeting, if not before.

Rate cuts on table

The combination of recent sour economic data and the crisis "suggests that the outlook for growth has worsened and that the downside risks to growth have increased," Bernanke told the National Association of Business Economics. As a result, the central bank "will need to consider whether the current stance of policy remains appropriate," a clear sign that rate cuts are on the table.

Under Bernanke, the Fed has cut rates between regularly scheduled meetings just once, this past January. But Bernanke used milder language Tuesday than he did in an early January speech that foreshadowed that cut, suggesting there is no certainty the Fed will move as quickly and aggressively as many Wall Street analysts are forecasting.

In particular, some Fed leaders have indicated in speeches that they think that rate cuts won't have their intended impact — of lowering borrowing costs and thus stimulating the economy — so long as world credit markets remain a mess. And they worry that the price of oil has been so volatile lately that rate cuts could end up hurting Americans' purchasing power by driving the price of oil up and the value of the dollar down.

The financial crisis strikes at the heart of Americans' ability to continue buying the things they need, Bernanke said in his speech.

"Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit," Bernanke said. "Banks are also reducing credit card limits, and denial rates on automobile loans reportedly are rising."

Offering fresh evidence of the depth of the problem, the Fed released data Tuesday indicating that the amount of consumer debt Americans have outstanding had its first monthly decline in a decade in August. And that was before the credit crisis deepened in September and October.

Although a rate cut would be aimed at encouraging overall economic growth, the new Fed action on commercial paper is designed to get more at the nub of the problem, a crisis of confidence among banks and other lenders.

The Fed is using emergency authority it was granted during the Depression to lend to any "individual, partnership or corporation," in "unusual and exigent circumstances." It used that authority two other times this year — to rescue Bear Stearns and take over American International Group. This time, for the commercial paper program, the Treasury Department will help provide funding.

In previous lending programs this year, the Fed has loaned only against strong collateral. But now the Fed will even take on "unsecured" debt, or that which is backed only by the faith of the company borrowing money. It will require insurance fees on companies borrowing money with unsecured debt to protect against losses.

Critically, the Fed will buy debt that is for three-month terms. Lately, a wide variety of companies have only been able to borrow money overnight. That has put them in a precarious position of having their fates decided every evening, as lenders must again review whether to renew the loans.

By having the government ready to buy slightly longer-term debt, that uncertainty should be diminished, Fed officials are hoping.

Information from the New York Times and the Associated Press was used in this report.

Market declines come as U.S. sets loans for businesses, weighs rate cut 10/08/08 [Last modified: Wednesday, October 8, 2008 4:44pm]

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