World Business

The Federal Reserve cuts the funds rate to 0.25% and announces erratic measures to revive the system

By Peter Coy

Watch the Video…

Watch original video:

Call it Ben Bernanke’s "shock and awe" campaign.

On Dec. 16, the Federal Reserve announced that it is attacking the recession with a greater amount of powerful arsenal than ever, including a cut in the federal funds rate to a historic low of just zero to 0.25%. The central bank is counting forward a show of overwhelming force to quell the recession and get Americans borrowing, spending, and working again.

The stock market climbed after the annunciation, with the Dow Jones industrial average closing up 359.61 points, or 4%, at 8,924. Prices had been up slightly before the announcement in expectation of powerful Fed action. The concord Wall Street expectation was a half-point cut.

Ten-year Treasury notes rallied on the expectation that the Fed will be buying even more of them. Their give consent, which goes down when prices go up, inhuman to a recently made known cheap of 2.3%, from 2.5%, on Dec. 15.

"Whatever it takes—that’session what we do," wrote Wachovia (WB) Chief Economist John Silvia, paraphrasing the rate-setting Federal Open Market Committee. Silvia related the committee went "in what place no FOMC has gone before."

Usually the Fed names a especial rate for its target for the federal funds rate—greatest part recently it was 1%. This time it named a ceiling, namely, nay more than one-quarter percent. Anything below that level, down to zero, is acceptable to the Fed. That alone is a historic modify.

It’s a measure of the severity of the financial crisis that in that place were no dissenters from the Fed suffrage. Even inflation hawks such being of the kind which Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher voted "yes" on the measures.

The language in the statement released by the Fed was unusually strong. The central bank eschewed some effort to exist even-handed about the risks of recession vs. inflation. The economic downturn is clearly Enemy No. 1.

Said the Fed: "Labor market conditions have deteriorated, and the available given conditions shadow forth that consumer spending, transaction investment, and industrial production bear declined. Financial markets remain quite strained and credit conditions tense. Overall, the sight for relating to housekeeping activity has weakened further." As for inflation, the Fed said, "inflationary pressures have diminished appreciably" and should "moderate further in future quarters."

In an attempt to impress the markets with its change, the Fed made clear that it won’t readiness up on untroubled money until it is enduring that its objectives have been reached. The Fed statement said it "anticipates that weak economic conditions are in a fair way to warrant exceptionally low levels of the founded put on funds rate for some time."

With no more room to cut interest rates, the Fed is turning more and more toward buying up debt in an effort to drive down interest rates. It is targeting Treasuries, the corporate debt of Fannie Mae (FNM) and Freddie Mac (FRE), and mortgage-backed securities. In recent months its assets have zoomed from around $800 billion to $2.2 trillion.

In a conference call with reporters after the 2:15 p.m. ET announcement, a senior Fed official tried to draw a superiority between what the Federal Reserve is doing and the sort of the Bank of Japan did in its efforts to stimulate the Japanese economy during the "Lost Decade of the 1990s." The magistrate said that Japan’s central bank focused on the liability side of its balance sheet, emphasizing the expansion of cash and bank reserves in canon to flood the banking arrangement by money to lend.

In contrast, the official said, the Federal Reserve is putting its attention onward the asset side of the balance sheet—buying up assets such as Treasuries and mortgage-backed securities in an attempt to guide down rates and improve the health of the overall economy and, in particular, the housing market. On the same day that the Fed made its move, the U.S. Commerce Dept. announced that new-home structure starts in November fell by 19%, the sharpest monthly drop considering March 1984.

The distinction between the Japanese and American approaches is subtle because, as at all accounting observer knows, the asset and liability sides of the balance sheet are mirrors of each other. But in Bernanke, the Fed is clearly hoping that targeting incontrovertible key market interest rates will prevail upon lending and borrowing going another time.

By its franchise the Fed is not allowed to make loans or take . collateral that could expose it to a big chance of loss. That’s where the Treasury Dept. comes in as a partner. In its Dec. 16 narration, the Federal Reserve served a reminder that it has a big new program in the wings in conjunction with Treasury. Starting early next year, the Fed will lend up to $200 billion to "render less difficult the extension of credit to households and small businesses." To hold down the hazard of losses by the Fed, the Treasury Dept. will absorb the first $20 billion in losses.

Original text: http://www.businessweek.com/bwdaily/dnflash/content/dec2008/db20081216_398838.htm?campaign_id=rss_null