Fed's moves to rescue economy no sure thing

WASHINGTON — All eyes are on the Federal Reserve today as its policymaking committee tries to spark the sick U.S. economy back to health, slashing short-term interest rates by what Wall Street believes may be a full percentage point.

As recently as Friday, investors were signaling they expected the Fed to cut rates half a percentage point. But that was before the spectacular weekend collapse of investment bank Bear Stearns, whose value stood at $3.5 billion Friday before it was sold Sunday night for just $236 million to JPMorgan Chase after a run on it by investors.

Sunday night, the Fed also widened access to credit like never before in a muscular bid to keep banks and other institutions lending and corporations and investors borrowing.

Making a quarter-point cut in its discount rate, which it charges as the lender of last resort to banks, the Fed extended the loan-repayment time frame to 90 days from the normal 30 day. It also accepted as collateral a broad range of financial instruments, including mortgage bonds, and made credit available to not just investment banks but also securities dealers.

"These moves by the Fed are a prelude to additional bold action to reduce rates," said Brian Bethune, U.S. economist with forecaster Global Insight in Lexington, Mass. He predicted a full percentage-point cut.

With the quick collapse of Bear Stearns, fears are mounting about whether other financial companies may fall. Many believe the country has already sunk into recession and the problems — if not contained — will deepen and prolong the pain.

"The Fed is on high alert — something you don't see but once every quarter century; maybe, in this case, since the Great Depression. This is a very unusual period," said Mark Zandi, chief economist at Moody's Economy.com.

That's because the Fed is having to fight multiple battles at the same time: a housing collapse, a severe credit crunch and Wall Street turmoil that threatens the stability of the entire U.S. financial system.

All those problems feed on each other, creating a vicious cycle that can be hard for the Fed and other policymakers to break. The weight of those troubles is like a millstone on the economy.

"Now the issue is fighting the deeper recession," said Bethune. "It has kind of moved to another level. The fires are spreading," he said.

To limit the damage, Bernanke and his colleagues may ratchet down a key interest rate to the lowest it has been since late 2004. Because that rate affects a wide range of rates charged to millions of consumer and businesses, it is the Fed's most potent tool for reviving economic activity.

If that happens, commercial banks' prime lending rate on certain credit cards, home-equity lines of credit and other loans would drop by a corresponding amount, to 5 percent from 6 percent.

The Fed's goal, since embarking on a rate-cutting campaign in September, is to induce people and businesses to boost spending, thus bolstering the economy.

What such low interest rates would mean for consumers isn't clear, since turmoil in the credit markets means banks aren't lending. Instead, they are hording capital to shore up their balance sheets.

The Fed has already cut the funds rate from 5.25 percent in September to 3 percent in January. That's done little to revive the economy.

There were glimmers of hope Monday as the difference between yields on mortgage bonds and other safer financial instruments — called the spread — narrowed. One day does not make a trend, but it's a possible sign that the fear gripping credit markets could be easing.

"These areas have tended to lead other areas of credit, so if we can hold onto these recent gains, there should be improvement in the tone of risk in general," said Michael Darda, chief economist for MKM Partners.

Lyle Gramley, a former Fed governor who has spent more than 50 years studying financial markets, is less optimistic

"If you look back at postwar recessions, I thought I knew that when the Fed pushed the accelerator, we'd leave problems behind. We just don't know that now — that's one of the most scary parts of the situation that we find ourselves in," Gramley said.

He believes that taxpayer dollars and more government intervention are needed.

Although U.S. stocks averted disaster Monday, share prices for financial sector players were hammered as concerns persisted about whether other big players were vulnerable to a run by investors, as Bear Stearns was.

"You know the old saying about cockroaches: There's never just one," said Howard Simons, president of Rosewood Trading, an economic research firm in Glenview, Ill. "One thing we've learned the hard way over the past year is, just when you think there's no more bad news, there's more bad news."

"You're going to have some very weak players pushed out of business," said Joseph Battipaglia, chief investment officer at Ryan Beck.

He said JPMorgan's buy of Bear Stearns and Bank of America's acquisition of mortgage lender Countrywide Financial are probably not the only rescues the industry will witness during this credit crisis.

Investment bank Lehman Brothers, which like Bear Stearns bet heavily on mortgage bonds that are now toxic, saw its shares fall 19 percent, after a 15 percent fall on Friday. Shares of Morgan Stanley fell 8 percent, Citigroup 6 percent, Merrill Lynch 5.4 percent and Goldman Sachs 3.7 percent.

Material from The Associated Press was used in this report.