Fed Cuts Bank-to-Bank Rate to Calm Markets

Aug. 17, 2007 — -- The Federal Reserve has finally been able to calm the stock market.

Early this morning, before the market opened, the central bank announced that it approved a half-percentage point cut in its discount rate on loans to banks -- a move that sent stocks skyrocketing.

And surprisingly that's where they stayed through the close.

The past few weeks have seen extreme volatility with stocks dramatically falling, rising and falling again all within the same trading day.

But as we close out another bad week on Wall Street it appears that the Federal Reserve's move has brought stability back to the markets -- at least for now.

Moments after the Fed's decision to cut the interest rate, stock futures surged. When the stock market opened about an hour later, the Dow Jones industrial average went up about 320 points and the NASDAQ was up more than 65 points.

Those giant gains edged back slightly by late morning but stocks generally held up throughout the day closing up significantly.

The Dow closed up 233 points, a 1.82-percent gain. The NASDAQ closed up 54 points, a 2.2 percent increase.

This was the first day the markets closed up in seven trading days.

The Fed's move changes a rate the Fed charges to make direct loans to banks. It lowered this "discount window" rate from 6.25 percent to 5.75 percent.

The Fed did not change its target for the more important federal funds rate, which has remained at 5.25 percent for more than a year.

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the Fed said in a statement today. "Although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably."

Many investors on Wall Street have been calling for the Fed and its relatively new chairman, Ben Bernanke, to take some type of action.

Others have warned that it is not the Fed's role to bail out overzealous investors who made poor decisions and that any cut by the central simply rewards those risk takers and undermines the overall market.

Last week, the Fed infused more money into the lending markets in an attempt to calm fears over housing and credit problems.

But that was not enough — this week has seen the market continue its bumpy fall.

Thursday, the Dow Jones industrial average plunged more than 340 points early in the day only to see a late-afternoon rally, closing the day down less than 16 points.

If the market fall continues, some say the Fed might be forced to cut its federal funds rate, which directly impacts consumer lending. Such a cut would mean lower interest rates for mortgages, credit cards and would make it easier for corporations to borrow.

The Fed signaled that it would take further action if it is needed.

"The committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets," the Fed said in its statement.

The Fed is expected to next decide what to do with that key federal funds rate on Sept. 18. But today's statement shows that it might be willing to meet sooner.

The decision to change one rate but not the other means that the Fed believes the market problems are being caused by the availability of cash, not the rate at which people borrow money.

The markets have been on a wild ride in the last month. July started with a bang with the Dow quickly climbing, closing July 19 at a new record close: 14,000.41.

But since crossing that milestone, stocks have been on a rocky downslide — falling 200 points one day, climbing 150 the next and then falling dramatically the next day.

At one point Thursday, the Dow fell below 12,600 — a 10 percent reduction from the 14,000 mark, a technical market correction.

This unusual market volatility has been caused by continuing fears about the impact of subprime mortgage foreclosures and the subsequent tightening of world credit markets.

Many investors on Wall Street had purchased bundles mortgages and have struggled to figure out how deeply affected they are by foreclosures.