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Fed tries to lower rates with a ‘twist’

$400b bond action angers Republicans, sends stocks down

By Megan Woolhouse
Globe Staff / September 22, 2011

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The Federal Reserve took steps to further lower interest rates yesterday by buying and selling $400 billion in bonds, a move that angered congressional Republicans and caused the stock market to plummet in the final hours of trading.

The Fed said the decision would lower the cost of borrowing money and improve overall financial conditions, but some economists and businesses gave it a lukewarm reception saying that interest rates are already at historic lows and even lower rates are unlikely to spark growth or hiring.

Interest rates and credit are not the problem, said Nariman Behravesh, chief economist at IHS Global Insight in Lexington.

“Fear is a much bigger factor,’’ Behravesh said, noting national and global financial instability and policy gridlock. “This was an insurance policy, but I don’t think it’s going to make a big difference in boosting growth.’’

The Fed will purchase $400 billion in 6-to-30-year Treasury securities by the end of next June and sell an equal amount of shorter-term Treasury securities of three years or less. The move confirmed speculation that policy makers were planning an “Operation Twist’’ style program that would twist shorter-term investments into longer-term ones. Though larger in scale, the effort resembles a 1961 maneuver by the Fed nicknamed for a Chubby Checker song popular at the time.

According to a Fed statement yesterday afternoon, the strategy “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.’’ The interest rate on a 10-year Treasury note, for example, fell to a new low of 1.85 percent yesterday from an all-time low of 1.9 percent.

After the Fed’s announcement at 2:23 p.m., the Dow Jones industrial average fell 265 points. It closed at 11,124.84, down 283.82 points, or about 2.5 percent.

Four high-ranking congressional Republicans asked Fed chairman Ben S. Bernanke in a letter delivered Monday to refrain from taking steps to lower interest rates, suggesting it could escalate the risk of high inflation.

In its announcement, the Fed said inflation “appears to have moderated since earlier in the year,’’ noting that some commodity prices have declined. The Fed also said there were “other significant downside risks’’ facing the economy and cited “global financial strains.’’

Three of the Fed’s 10 voting committee members voted against the interest rate action.

Elizabeth Phelan, chairwoman of the Massachusetts Association of Mortgage Bankers, said lower rates could encourage more people to consider refinancing home loans, but she didn’t think it would have a dramatic impact.

“I’m not sure that in and of itself it is enough to pick us up from the economic issues we’re going through as a country,’’ she said. “Some of the core issues, like unemployment, those weigh more heavily on people going into new ventures and taking on additional debt.’’

Bernie Rubin, cofounder of Bernie & Phyl’s furniture stores, welcomed the interest rate reductions as the company looks to expand, but said it was impossible to know whether it will boost consumer spending.

“It certainly can’t hurt and may be just what the economy needs right now,’’ Rubin said.

Brian Bethune, an economics professor at Amherst College, said the last interest rate reduction, enacted by the Fed in August, has not yet generated many benefits, but the impact of such efforts is not always immediate. Corporations are hoarding cash right now, and consumers have drastically reined in spending. The Fed must “figure out what it can do to snap us out of this situation.’’

“It’s a big problem,’’ he said. “Realistically, the best thing they [the Fed] can do is reduce the risk of the economy falling into a recession. No one really expects that the Fed has a magic wand that can suddenly change the underlying circumstances.’’

Bernard Baumohl, chief global economist for the Economic Outlook Group, a Princeton, N.J., firm that advises institutional investors and hedge fund clients, called the action “nothing more than a distraction.’’

Many factors, including depressed housing prices and joblessness, are a drag on the economy, sapping consumer and business confidence. Businesses are sitting on more than $2 trillion in cash reserves and consumers are saving, not spending.

“There is such a lack of clarity about where the economy is going in the next 6 to 12 months,’’ he said. “And I don’t think today’s action will create any.’’

Megan Woolhouse can be reached at mwoolhouse@globe.com.


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