Fed will need backup, analysts say
Despite latest cut, government may have to intervene
The Federal Reserve yesterday followed its unprecedented actions to stabilize financial markets with another aggressive interest rate cut, but many analysts say the central bank will still need help from Congress and the Bush administration to right the struggling economy.
The Fed sliced its benchmark interest rate by three-quarters of a point, two days after it engineered the sale of sinking Wall Street investment firm Bear Stearns Cos. and opened its lending window to securities dealers for the first time in its history. The rate cut was less than the 1-point reduction that many analysts had expected, but still aggressive. It's only the second time since 1982 that policy makers have approved a single cut of three-quarters of a point.
The cut helped send stocks soaring. In addition, better-than-expected earnings from Wall Street firms Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. provided relief to investors worried that other investment firms would follow Bear Stearns into collapse.
The Dow Jones industrial average surged 420.41 points, its biggest one-day gain in nearly six years, to close at 12,392.66. The broader Standard & Poor's 500 index rose 54.14 to 1,330.74. The technology heavy Nasdaq Composite Index gained 91.25 to close at 2,268.26.
"The US financial system remains intact, massively supported by the Fed," said Allen Sinai, chief economist at Decision Economics Inc., a Boston financial market advisory firm. "The rate cuts and injections of liquidity have provided a positive stimulant in a very sick situation."
Liquidity is another word for money that keeps financial markets operating. The Fed, in addition to slicing interest rates, has injected hundreds of billions of dollars into the financial system as rising mortgage defaults and foreclosures threatened to bring financial and credit markets to a halt.
Yesterday's rate cut brings the Fed's benchmark to 2.25 percent, the lowest since late 2004. The Fed has cut the rate 3 percentage points since September, and many economists expect the Fed to keep cutting rates over the next few months.
Lowering interest rates aims to boost the economy by encouraging businesses and consumers to borrow and spend. But eroding confidence, undermined by the meltdown in housing and mortgage markets, has made lenders reluctant to make loans, and consumers reluctant to borrow, muting the impact of cheaper money.
As a result, economists say, the Fed's actions won't be enough to keep the economy from recession. Many forecast that the United States is already there.
"They've lost the battle to prevent a recession," said James O'Sullivan, economist at UBS AG in Stamford, Conn. "The new battle lines are being drawn, and they want to prevent a deep recession."
Some economists say the central bank can't do it alone, and the federal government needs to intervene directly into the housing market - even becoming the buyer of last resort for mortgage loans and securities. Fears of loan defaults and foreclosures have made it difficult, if not impossible, to sell these loans and securities in credit markets, limiting the money available for mortgages and leading to higher rates, tighter credit standards, and fewer buyers.
The result: weaker sales, falling prices, and more foreclosures.
"Congress and the president have to come in with a rescue package that takes some of the risk off mortgage portfolios," said Nariman Behravesh, chief economist at Global Insight, a Waltham forecasting firm. "They've really got to get ahead of this, find a systemic solution, and stop moving from crisis to crisis."
So far, the Bush administration has resisted intervention of this scale, analysts said. President Bush, in Florida yesterday to speak on trade and raise money for Republicans, said the Fed and US Treasury have moved swiftly to stabilize the economy. He said the administration is ready to take additional action if needed.
US Representative Barney Frank, Democrat of Newton and chairman of the House Financial Services Committee, said there's no doubt greater federal intervention is needed to address the root cause of the problems: the subprime crisis that put homeowners into mortgages they couldn't afford. Frank recently proposed legislation that would provide up to $300 billion in federal loan guarantees to help refinance struggling homeowners into affordable mortgages.
"This is not a normal cyclical recession," Frank said. "Why is this recession different than any other recession? Subprime. And you have to deal with it."
Robert Gavin can be reached at rgavin@globe.com. Material from Bloomberg News is included in this report.
