Odds seem to favor rate cut

WASHINGTON — With their interest-rate decision today, Chairman Ben Bernanke and his colleagues at the Federal Reserve will convey just how worried they are that banks and other financial institutions are putting the economy at risk by hoarding cash.

The Fed's policymaking committee will decide whether to lower a short-term interest rate for the third time this year.

Based on prices in futures markets Monday, investors believed that there is a 68 percent chance that the Fed will cut the federal-funds rate by a quarter of a percentage point, a 30 percent chance of a half-point cut and a 2 percent chance that the Fed will leave the rate at 4.5 percent.

The committee's decision is usually announced at 11:15 a.m. local time.

The decision could hinge on indicators that capture the degree to which banks are afraid to loan money to each other, in addition to the employment outlook and inflation expectations.

The more worried the Fed is about lenders becoming unwilling to make loans, the more likely it is to cut by half a percentage point to stimulate the economy.

The economy is threatened not merely by a steep downturn in housing, economists say and Fed leaders have acknowledged in recent speeches.

They also worry that financial institutions that would normally lend money to consumers and businesses and help keep the economy growing are becoming fearful of massive losses from bad loans.

Instead of making the situation better, they could make it worse by offering loans only at higher cost — something that happened last month.

"Bankers and other lenders are becoming more cautious and more choosy in who they lend to," said Bruce McCain, head of investment strategy at Key Private Bank. "Every person or borrower who is priced out of the market or refused a loan is that much less stimulus to the economy."

One possibility is that Fed policymakers today will announce measures besides cutting the federal-funds rate that might help ease the liquidity crunch.

"Central banks, including the Federal Reserve, need to give some thought to how all their liquidity facilities can remain effective when financial markets are under stress," said Vice Chairman Donald Kohn in a recent speech.

Moreover, the problem is more complicated than a lack of liquidity, or access to cash.

"The problem in the banking system is not one of liquidity, but of a potential shortage of capital," said Carnegie Mellon economist Marvin Goodfriend.

By that theory, the best thing that can happen would be for banks to raise more money.

There was an example of that Monday when UBS, Europe's largest bank, said it was raising $11.5 billion from two foreign investors, and mortgage-lender Washington Mutual said it will raise $2.5 billion by issuing convertible stock.

Since its last meeting, Fed Chairman Bernanke said in a recent speech, the housing market has deteriorated sharply (a worsening that was expected), the labor market has held up fairly well, but consumer spending has slowed a bit more than he had forecast.

But Bernanke has observed that decisions on whether to cut interest rates should be based on where the economy is likely to be months down the road — because interest-rate cuts spread through the economy only gradually.