Federal Reserve Slashes Interest Rate by a Half-Point; Market Soars

Tuesday September 18, 7:40 pm ET
By Jeannine Aversa, AP Economics Writer

WASHINGTON (AP) -- In a bold strike, the Federal Reserve slashed a key interest rate by a half point on Tuesday -- the first cut in over four years -- and left the door open to further relief to prevent a painful housing slump and jarring credit crunch from driving the country into recession.

Wall Street responded enthusiastically, propelling stocks up 335.97 points -- its biggest one-day point jump in nearly five years. Politicians, shaken by record-high home foreclosures, also welcomed the move.

In a crucial and anxiously awaited decision, Federal Reserve Chairman Ben Bernanke and his central bank colleagues lowered an important interest rate to 4.75 percent. Economic and political pressure has been building on the Fed to act.

As a result, Wells Fargo, Bank of America and other commercial banks dropped their prime lending rate charged to millions of borrowers by a corresponding amount to 7.75 percent.

Whether Bernanke can handle the crisis successfully is the biggest challenge he has faced in his 19 months at the Fed helm.

"Today's action is intended to help forestall some adverse effects on the economy that might otherwise arise from disruptions in financial markets and to promote moderate growth over time," the Fed said in a statement released after its closed-door meeting.

The Fed's action means borrowers who can obtain credit should see rates drop on a variety of loans. It will become less expensive for people to finance certain credit card debt and for homeowners to take out popular home equity lines of credit, which often are used to pay for education, home improvements or medical bills.

And, it will help some homeowners whose adjustable rate mortgages reset in the fall. Those rates will still go up but not by as much as they otherwise could have, analysts said.

Less immediate will be relief for the country's economic health. The rate reduction could take three to nine months to ripple through the economy and bolster overall activity.

The aggressive action underscored the Fed's resolve.

"The Fed has rolled out the heavy artillery here. Bernanke is not being timid," said Brian Bethune, economist at Global Insight. "The Fed has seen the problems. It is not trying to put out a forest fire with a bucket of water," he said.

Bethune and some other analysts predict the Fed will lower rates again -- probably by a more modest one-quarter percentage point -- at its next meeting in October. Another rate reduction could come in December, the last meeting of this year, if the economy were to falter.

But economist Richard Yamarone of Argus Research is in the camp that no more help will be needed. "It is one and they are done," he predicted.

The Fed's economic assessment was somber.

"The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally, " the Fed said.

Fears that the troubled housing market and credit problems could short-circuit the six-year-old economic expansion have shaken Wall Street. Financial turmoil has intensified since the Fed's last scheduled meeting in early August.

The biggest worry is that people and businesses will cut back on their spending and investment, throwing the economy into a tailspin. Tuesday's rate cut is aimed at making sure that doesn't happen.

"By going with a half-point reduction, Bernanke is eschewing a gradualistic approach. The patient -- the economy -- has a bad flu and you don't want it to turn into pneumonia. So you don't want to mess around," said Terry Connelly, dean of Golden Gate University's Ageno School of Business.

The situation for the Fed could become tricky.

"Some inflation risks remain," Fed policymakers said. There have been some inflation improvements. Wholesale prices fell 1.4 percent in August, the government reported Tuesday. But threats remain: Oil prices climbed to a new high on Tuesday, above $81 a barrel.

The Fed left the door open to its next rate move, saying it will "act as needed to foster price stability and sustainable economic growth."

Ex Federal Reserve Chairman Alan Greenspan, in an interview Monday with The Associated Press, said the odds of a recession are growing.

"Obviously the odds have moved up to more than a third, but I doubt if we are anywhere near 50 percent yet." Earlier this year, his prediction of a one-in-three chance of a recession caused Wall Street to nosedive.

Analysts expect the economy to slow to a rate of about 2 percent in the current July-to-September quarter. That would be just half the rate of the previous three months. Growth in the final three months of this year could turn out even weaker.

The free flow of credit is important to the smooth functioning of the national economy. If credit becomes too difficult to get, it can put a damper on peoples' ability to buy big-ticket items such as homes, cars and appliances. And it can crimp businesses' capital investment and hiring.

Employers cut 4,000 jobs in August, the first time the economy has lost jobs in four years. The unemployment rate, now at 4.6 percent, is expected to climb close to 5 percent by the year's end.

The worst housing slump in 16 years is being painfully felt. Higher interest rates squeezed homeowners, especially "subprime" borrowers with blemished credit or low incomes. Foreclosures set records and late payments spiked. Lenders were forced out of business. Hedge funds and other investors in subprime-related mortgage securities got clobbered.

The credit crisis spread beyond the subprime market to more creditworthy borrowers.

Bernanke and his colleagues were accused of being behind the curve when they held their key interest rate steady at 5.25 percent at their last meeting on Aug. 7. Just days later the Fed was forced to pump billions of dollars into the U.S. financial system to get institutions over the credit hump. Then on Aug. 17 the Fed took even more aggressive action and cut its lending rate for banks. The Fed on Tuesday lowered that lending rate again.