Tuesday, October 7, 2008

Bernanke Signals Fed May Cut Rates as Crisis Deepens (Update3)

Bernanke Signals Fed May Cut Rates as Crisis Deepens (Update3)

By Scott Lanman
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Oct. 7 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke signaled policy makers are ready to lower interest rates as the credit freeze poses an escalating danger to the economy.

The world financial system is under ``extraordinary stress'' and history shows that severe instability ``can take a heavy toll on the broader economy if left unchecked,'' Bernanke said in a speech in Washington. ``The Federal Reserve will need to consider whether the current stance of policy remains appropriate.''

Today's remarks indicate the central bank's record loans to unblock credit markets are insufficient to prevent a deeper economic downturn. Investors increased bets the Fed will cut its main rate by as much as three-quarters of a point this month after stock indexes slumped to four-year lows and premiums on loans between banks climbed to a record.

``It would be unwise to wait'' after ``such a clear message'' from Bernanke, former San Francisco Fed President Robert Parry said in an interview with Bloomberg Television. A reduction by 1 percentage point would be the ``appropriate amount,'' though the Fed may not go that far, he said.

Stocks slid after Bernanke's remarks failed to assuage investors' concerns about deteriorating financial markets, with the Standard & Poor's 500 Stock Index falling 5.7 percent to the lowest close in five years.

Minutes of the Federal Open Market Committee's Sept. 16 meeting, released in Washington today, showed that some officials then saw a need for a rate cut should there be a ``significant worsening of the growth outlook.''

Fed Meeting

The FOMC, which next gathers Oct. 28-29, cut its target rate for overnight loans between banks by 3.25 percentage points from September to April, then left it unchanged at 2 percent for three meetings.

``With financial markets in such turmoil the odds of an inter-meeting cut are now above 50/50,'' said former Fed governor Lyle Gramley, now senior economic adviser at the Stanford Group Co. in Washington.

Traders see about 40 percent odds of a three-quarter-point cut in rates at or before this month's meeting, futures prices showed as of 4:09 p.m. in New York. The probability of at least a half-point cut remained at 100 percent.

Since Bernanke's last public address, on Sept. 24 to Congress, the Standard & Poor's 500 Stock Index has lost 14 percent, the three-month London interbank offered rate climbed 0.84 percentage point to 4.32 percent and government figures showed U.S. payrolls slid by the most in five years last month.

Change in Assessment

``The combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased,'' Bernanke said at a conference of the National Association for Business Economics today. ``At the same time, the outlook for inflation has improved somewhat, though it remains uncertain.''

The economic slowdown has now ``spread outside the housing sector,'' and consumer spending has ``contracted significantly'' since May when adjusting for inflation, the Fed chief said.

Even households with ``good credit histories'' are finding it harder to get home loans, and disruptions in the commercial paper market have made it more difficult for companies to get working capital, Bernanke said today.

Dangers posed by the intensifying credit crisis have justified the Fed and Treasury taking unprecedented actions in recent weeks, Bernanke said.

``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,'' said Bernanke, 54, a scholar of the Great Depression and former Princeton University economist.

Pumping Cash

The Fed is pumping more than $1 trillion of short-term cash loans into the banking system to head off the global liquidity squeeze. Earlier today, Bernanke moved to backstop the short-term corporate debt market.

The Fed said today it would start buying three-month commercial paper, after the market slid to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis. The effort comes on top of an expansion yesterday of the central bank's auctions of cash to banks to as much as $900 billion.

Also this week, the Treasury is putting in place its plan to inject as much as $700 billion into the financial system through purchases of distressed assets or potential direct investments into companies.

`Continued Efforts'

The Treasury program should, ``with time,'' help make credit flow and revive economic growth, Bernanke said today. ``Continued efforts to stabilize the financial markets are essential,'' and the central bank ``will continue to use the tools at its disposal to improve market functioning and liquidity,'' he added.

The Fed chief also reviewed the central bank's decisions to forego a rescue of Lehman Brothers Holdings Inc. last month, and its move days later to take over American International Group Inc. In March, the Fed agreed to buy $29 billion of Bear Stearns Cos. assets to prevent its failure and secure its takeover by JPMorgan Chase & Co.

Policy makers had limited choices as Lehman approached bankruptcy, even though the firm's collapse would contribute to ``extraordinarily turbulent conditions'' in financial markets, Bernanke said.

Lehman Risk

A government-facilitated sale, or outright support, would have required ``a sizable injection of public funds'' into Lehman and ``would have involved the assumption by taxpayers of billions of dollars of expected losses.'' Bernanke said that neither the Treasury nor the Fed had the authority to ``commit public money in that way.''

Bernanke has pushed the limits of the Fed's powers to create an array of unprecedented lending programs as the credit crisis spread from banks to securities firms, mutual funds, the biggest U.S. insurer and now corporate America.

Over the past week the Fed announced plans to pump an additional $1 trillion into the global financial system through auctions of cash loans to banks. That's on top of its $147 billion in loans to Wall Street bond dealers and $152 billion in lending to backstop money market mutual funds as of Oct. 1.

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