Washington – The Federal Reserve added billions of dollars more to the banking system Wednesday in a fight to keep a credit crisis from derailing the economy. Speculation is growing that the Fed also will cut interest rates, perhaps as soon as next month.
The Fed has not lowered rates in more than four years. But many economists, while watching another wild day on Wall Street, said they believe the central bank would do just that in the weeks ahead if the market turmoil becomes severe enough.
The Dow Jones industrial average fell 167.45 points Wednesday to close at 12,861.47. It was the Dow’s first close below 13,000 since April 24 and left the blue-chip index down more than 8 percent from its record close of 14,000.41 reached July 19.
“With financial markets in disarray and the potential for a credit crunch, the Fed will have little choice but to ease policy,” said Mark Zandi, chief economist at Moody’s .
By pumping an additional $7 billion into the banking system, the Fed sought to keep the federal funds rate, the interest that banks charge each other for overnight loans, from rising above the Fed’s current target of 5.25 percent.
Since Aug. 9, the Fed has injected $71 billion into the banking system.
The $38 billion boost from the Fed on Friday was the largest one-day cash infusion since the attacks of Sept. 11, 2001.
Echo of Asian contagion
To many analysts, the current situation is similar to the 1997-98 global financial crisis, which began in Thailand and eventually pushed 40 percent of the worldwide economy into recession.
Then-Fed Chairman Alan Greenspan and his colleagues pushed ahead with a series of one-quarter-percentage-point rate cuts in the fall of 1998. The moves were enough to get financial markets working again and keep the U.S. economy from recession.
While the current situation has not become as dire, analysts said it could quickly develop into a full-blown credit crisis if there are more announcements in coming days of serious credit problems in major hedge funds or banks. Such problems had their start in rising defaults in the market for subprime mortgages, loans extended to borrowers with weak credit histories.
“Walking on eggshells”
“This is a day-to-day proposition. The credit markets are still walking on eggshells. Almost every day, we get another bad announcement,” said David Jones, head of DMJ Advisors, a Denver-based consulting firm.
The current market volatility represents the first big test for Fed Chairman Ben Bernanke, who took over in February 2006 when Greenspan stepped down after 18 1/2 years at the helm of the Fed.
Some analysts said unless conditions in financial markets get much more severe, Bernanke and other Fed officials will wait to cut rates after they see more information pointing to an economic slowdown.
“The Fed does not want to be seen as bailing out financial markets for their bad investment decisions,” said Lyle Gramley, a former Fed board member and now a senior adviser at the Schwab Washington Research Group.
However, Gramley said he believed incoming data would show a serious enough impact on the overall economy from the slump in housing and the credit troubles that the Fed will be ready to cut rates by a quarter- point at its October meeting and in December at its final meeting of the year.
