Fed Cuts Key Interest Rate .75%
By SCOTT MAYEROWITZ
ABC NEWS Business Unit
March 18, 2008 —
Wall Street bounced back today with a massive rally thanks to better-than-expected earnings reports from brokerages Goldman Sachs and Lehman Brothers and then another rate cut by the Federal Reserve.
The Dow Jones Industrial Average closed up 420 points, the NASDAQ up 91 points and the Standard & Poor's 500 was up 54 points.
Shares of Goldman closed up 16 percent and Lehman Brothers saw a whopping 43 percent increase in its share price today.
While it was the earnings reports that started the rally this morning, a three-quarters of a percentage point rate cut this afternoon by the Fed pushed the markets even higher.
The deep cut -- one in a series of recent cuts -- is aimed at trying to avoid a prolonged recession.
After today's move, the key Federal Funds rate now stands at 2.25 percent, down from 5.25 percent in the summer. Since August, the Federal Reserve and chairman Ben Bernanke have cut the rate five times. The last time interest rates were this low was February 2005.
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"Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened," the Fed said in a statement. "Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters."
"Inflation has been elevated, and some indicators of inflation expectations have risen," the Fed continued. "The committee expects inflation to moderate in coming quarters, reflecting a projected leveling out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
Wall Street initially did not like the move by the Fed. Stocks had been trading up all morning thanks to better-than-expected earnings reports from Wall Street brokerages Goldman Sachs and Lehman Brothers.
The Dow Jones industrial average was up 285 points before the 2:15 p.m. announcement. Within 15 minutes of the news, the Dow Jones Industrial Average was up just 125 points. But that quickly changed. Just an hour after the announcement, stocks were at new highs for the day, with the Dow up 330 points. At the end of the day, the Dow closed up a more than 400 points.
This morning U.S. Treasury Secretary Henry Paulson stopped short of saying the country was in a recession, but acknowledged "the economy is in sharp decline."
"The label they put on it is much less important to me than what we do about it," Paulson said on "Good Morning America" today. "The American people feel the slowdown and we feel the slowdown."
Washington policymakers have been struggling for months with how to deal with a mortgage and credit crisis that is now expanding to the greater economy.
Some critics have questioned why the government is using taxpayer dollars to bail out Wall Street titans, like Bear Stearns, while thousands of Americans struggle to stave off housing foreclosure and receive nothing.
According to the National Community Reinvestment Coalition, corporations have received $230 billion in federal aid compared to nothing for homeowners. But Paulson said the government is trying to help individual Americans, too.
"We also are working very hard on this mortgage foreclosure problem to avoid foreclosures that are affordable," he said. "We're focused on making this work."
He pointed to the stimulus package Congress and the president approved. Starting May 2, 130 million Americans are expected to get checks which the government hopes they will spend at stores.
"[We want to] deal with and help homeowners who want to stay in their homes and have the ability to do that," Paulson said.
Some on Wall Street were hoping for a full one percentage point cut.
Goldman Sachs analysts said Monday they expected today a one percentage point reduction -- bringing the key interest rate to just 2 percent.
Such a "rate cut would be a clear sign that Fed officials see urgency in the current situation and a need to bolster confidence, both in the financial markets and in the public at large," the Goldman analysts wrote. "Anything less … will risk an adverse market response that could aggravate the fragility Fed officials are trying to repair."
Robert V. DiClemente, of the Economic & Market Analysis Group, said last week that such a larger cut is needed.
"Aggressive action is necessary to try and stabilize the financial setting," DiClemente said.
What a Rate Cut Means
While Wall Street might love such a cut, the Fed's action will ripple throughout other parts of the economy.
The most dramatic and immediate result is that the U.S. dollar will fall further against foreign currencies whose central banks haven't been as aggressive at cutting rates.
A lower dollar also means higher oil prices. Last week, oil closed at the staggering price of $110.33. In January 2007 oil traded at less than half that: about $50 a barrel.
Many Americans are feeling those higher prices at the pump, where a gallon of regular gas now costs an average of $3.28 across the country, according to the government's Energy Information Administration.
By May or June, the government says the average price will peak at $3.50. Some parts of the country could easily see more than $4 a gallon.
The cheap dollar, however, helps some companies, especially those that manufacture goods in the United States and then sell them overseas. Those products are now cheaper for the foreign buyers and demand has gone up.
Things are also looking pretty good for farmers, who have seen large worldwide demand for corn and wheat. American companies that sell oil and those who mine minerals such as gold, copper and silver are seeing strong profits.
But there's more bad news than good these days. Foreclosures are at a record high, with RealtyTrac reporting foreclosure notices nationwide up nearly 60 percent compared with a year ago.
Americans are starting to lose their jobs.
According to government figures, the nation's employers laid off 63,000 workers during February. The last time we saw a bigger drop was March 2003. Jobs were lost in temporary employment, trucking, retail, manufacturing and construction sectors.
What the Government Is Doing
The government has not yet declared an official recession -- that usually happens a few months after a recession has started -- but government officials appear to going out of their way to avoid using the word "recession."
On Monday, President Bush said, "Right now we're dealing with a difficult situation," while discussing the economy.
The most dramatic move by Bush and Congress was the passing of a $168 billion economic stimulus package that will provide checks to 130 million Americans.
Starting on May 2, the IRS will mail out payments of up to $600 for individuals or $1,200 for a married couple filing jointly; there are additional payments of $300 for each qualifying child younger than 17. The checks decrease in size for those at the top of the income scale.
The Federal Reserve has cut interest rates since August to stimulate growth. To make it easier for banks to lend money, the Fed has also expanded who qualifies for short-term loans from the government and has extended the once-overnight loan program into one for up to 90 days.
This final move -- which came after the collapse of Bear Stearns -- is one heralded this week for helping to keep other Wall Street firms from folding.
Finally, the government has brought together the country's major banks to change the guidelines for refinancing and issues mortgages. They have set up counseling hot lines and have tried to help those who face foreclosure. Results so far are mixed.
Is it Working?
Robert Brusca, chief economist at Fact and Opinion Economics, thinks the president hasn't gone far enough.
"The administration seems to have no stomach for taking action," Brusca told ABC News. "This is a president that had no trouble intervening in Iraq, but does not want to intervene in the housing mess. It's as though we should worship the private sector even though it is what got us into this mess."
Peter D. Schiff, president of Euro Pacific Capital Inc., thinks the stimulus plan will make the current economic situation worse.
"Our economy is suffering from years of reckless consumer borrowing and spending," he said. "The last thing we need now is policies that encourage more of the behavior that got us into this mess in the first place. What we do need is more savings and production, and less borrowing and consumption."
But others think that government shouldn't interfere too much with the market.
"Without changing the reasonable balance between public policy and private markets they are doing enough," said John Silvia, chief economist for Wachovia. "Sometimes you have to take the medicine. Time and some profit losses will clear up the log jam."
Bernard Baumohl, chief economist of the Economic Outlook Group, added: "This is a presidential election year so they will not leave any stone unturned to help."