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Facing the Recession :
How Bad Will It Be?
PREVIOUS ISSUES
The surprise rate cuts on Oct. 8 are meant to send a message to investors about how serious the world's central bankers take the crisis gripping financial markets. Plunging stock prices may not immediately reverse course. But actions that accompany the rate cuts in the U.S. and elsewhere are far more important and will do what they're designed to do: prevent the global economy from grinding to a halt.
The Federal Reserve is broadening the definition -- by any measure -- of its role as the lender of last resort. It will buy up as much as it needs to of the $1.6-trillion commercial paper market, which has been frozen for nearly three weeks, in order to get money flowing again to Main Street. Companies of every size and state and local governments faced the specter of payrolls not being met and vendors not being paid.
The Fed's commercial paper purchases will alleviate those fears. "Hopefully, this will create some breathing room," says Mark Zandi, chief economist at Moody's Economy.com, a research firm. The shutdown in the commercial paper market, where firms and local governments routinely borrow anywhere from overnight up to nine months for cash flow, isn't about the cost of money, it's about the lack of confidence among banks and investors. The rate cuts, however, will have some effect. They will lower borrowing costs for businesses and some consumers.
The Federal Open Market Committee unanimously voted to cut the federal funds rate, the rate banks charge each other for overnight lending, to 1.5% from 2%. The Fed also approved lowering the discount rate, the rate the Fed charges banks for overnight lending, to 1.75% from 2.25%. Banks quickly announced that they would lower their prime lending rate to 4.5% from 5%.
It was significant that the rate cuts were coordinated with other central banks, including in the U.K., the euro zone, Canada, Sweden and Switzerland. Japan issued a statement supporting the reductions, and China, Hong Kong and Australia also lowered their rates. All those nations are affected by the larger and longer-term issue of banks buckling under the toxic debt on their balance sheets.
In a rare intermeeting move to cut two key short-term rates, the Federal Reserve said, "The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability."
The Treasury also says it will accelerate the reverse auctions that will be held to buy up and sell off the bad debt owned by U.S. banks. And if the financial markets are still spiraling out of control, the U.S. rescue plan allows Treasury to buy preferred shares in banks, boosting their capital and enabling them to making loans to businesses.
Even with all this, another fiscal stimulus may be attempted before year-end, but that would be problematic in a lame-duck session of Congress.
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