Fed tries to shake stubborn rates with cut

Sam Zuckerman, SF Chronicle Staff Writer
Wednesday, March 19, 2008

Chairman Ben Bernanke and his fellow Fed policymakers approved an unusually large 0.75 percentage point cut in the federal funds rate, which serves as a benchmark for short-term loans such as adjustable-rate mortgages. The move followed a series of unprecedented steps taken by the nation’s central bank over the last week - including engineering the sale of near-bankrupt Wall Street giant Bear Stearns Cos. - aimed at shoring up a financial system shaken by huge losses in the housing market.

After the Fed’s move, stocks staged one of their biggest rallies in years. Major market indexes rose more than 3.5 percent, a signal that the Fed has succeeded in easing immediate fears of a financial system breakdown.

But while the Fed may have patched the financial world, economists say it is having a lot harder time carrying out its primary task: restoring economic growth.

The problem is that cuts in interest rates - the central bank’s basic tool for boosting the economy - aren’t working their magic. Simply put, when the Fed lowers its benchmark, which governs the rates banks charge each other for overnight loans, rates on many of the kinds of credit that really count in the everyday economy aren’t following suit. Those include fixed-rate mortgages and corporate and municipal bonds.

In six months, the Fed has cut its federal funds rate from an annual 5.25 percent to 2.25 percent, including Tuesday’s downward move. But the rates households and businesses pay to borrow money have stubbornly stayed high.

Banks cut back

“The rate cuts have not had much of a favorable effect,” said David Jones, chief executive of Florida financial consulting firm DMJ Advisors and author of a book on the Federal Reserve. “There’s so much risk in the market that banks are cutting back their lending to Joe Sixpack.”

Banks “did not adjust as the Fed adjusted,” said Michael Shapiro, a financing expert at Cartelligent, a Sausalito new car buying service. “The majority of banks didn’t do any cuts. And, if they did, it was by 0.25 or 0.5 (of a) percentage point.”

The financial system depends on a steady flow of loans between financial institutions. But in recent months, institutions became reluctant to lend to each other out of fear that housing-related losses would make big financial players unable to make good on loans.

Fed officials view such a freeze-up of the financial system as a dire threat to the economy and have gone all out in the last week to keep the market functioning. The central bank has done things it’s never done before, such as lending money to brokerage firms and taking mortgage securities as collateral. And it forced the sale of Bear Stearns to rival JPMorgan Chase & Co., guaranteeing the buyer against losses, to head off an imminent failure of the firm to pay its creditors.

“We could have had total financial market meltdown had they not taken those weekend actions,” Jones, the financial consultant, said.

Thanks to the Fed, total financial market meltdown may be delayed for as long as days, or even months.