WASHINGTON — Federal Reserve chairman Ben S. Bernanke suggested that the Fed will cut interest rates further in the days ahead as a result of the heightened risks to the economy from the severe financial crisis of the last month.
In a speech before the National Association of Business Economists, Mr. Bernanke said consumers and businesses have started to spend less as a result of spreading worries about the economy and reduced access to credit. Even people with good credit are having trouble obtaining mortgages and home equity loans, he said.
At the same time, the huge drop in oil prices from a record high over $147 in July to under $90 today has dramatically lowered the outlook for inflation, giving the Fed room to consider lowering rates, he said.
"The intensification of financial turmoil and the further impairment of the functioning of credit markets seem likely to increase the restraint on economic activity in the period ahead," he said. "Banks are reducing credit card limits, and denial rates on automobile loan applications reportedly are rising.
"Businesses, too, are confronting diminished access to credit. For example, disruptions in the commercial paper market and tightening of bank lending standards have made it more difficult for businesses to obtain the working capital they need to meet everyday operating expenses such as payrolls and inventories," he said.
The problems businesses are having raising cash through short-term debt sales prompted the Fed this morning to take the first-ever step of directly purchasing such unsecured debt from businesses and financial companies in the commercial paper market. Mr. Bernanke told the business economists that the move was necessary because the Fed's other direct lending programs for banks and Wall Street firms weren't working to calm that critical market.
The Fed's moves initially calmed stressed stock markets this morning, but stocks deteriorated rapidly during Mr. Bernanke's speech as investors were disappointed the Fed didn't indicate any rush to cut interest rates. The Dow Jones Industrial Average was down about 100 points at the beginning of the speech but quickly fell to a loss of 345 points as of 2 p.m.
Many analysts on Wall Street are calling for immediate, coordinated rate cuts from the Fed and its European counterpart.
Many believe the country is on the brink of, or already in, its first recession since 2001.
"The outlook for economic growth has worsened," Bernanke said in prepared remarks to the annual meeting here of the National Association for Business Economics.
All told, economic activity is likely to be "subdued" during the remainder of this year and into next year, Bernanke said. "The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth," he warned.
Meanwhile on Wall Street, the Federal Reserve took the extraordinary step Tuesday morning of moving to lend for the first time to businesses and financial companies that float short-term debt in the commercial paper market, which has been shut down for weeks.
Even top-rated businesses like GE and Caterpillar have had difficulty in recent weeks selling their short-term paper, and some companies have been shut out of the market altogether.
The Fed has many programs to lend to banks and Wall Street firms through its New York lending window, but this is the first time it will lend directly to U.S. businesses that are unable to roll over their debts and are facing a cash crisis.
The commercial paper market is one of the riskiest loan markets because the short-term debt in most cases is not backed with collateral and can be wiped out if the borrower files for bankruptcy, as happened in the case of Lehman Brothers last month. Many subprime mortgage companies borrowed in the market and then disappeared last year when the credit crisis struck, leaving their creditors stuck with billions in bad loans.
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In past lending programs for banks, the Fed always took collateral such as portfolios of Treasury bonds or mortgages in exchange for loans, to protect taxpayers in case the borrowers are unable to pay their obligations.
The new short-term loan program the Fed announced for businesses this morning will not require collateral on all the loans, but borrowers who do not provide collateral will be required to pay a fee, the Fed said.
"The commercial paper market has been under considerable strain in recent weeks as money market funds and other investors, themselves often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper," especially longer-term loans, the Fed board said in announcing the new program.
"As a result,the volume of outstanding commercial paper has shrunk, interest rates on longer-term commercial paper have increased significantly, and an increasingly high percentage of outstanding paper must now be refinanced each day."
"By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once against engage in lending," the Fed said.