- The Washington Times - Wednesday, March 19, 2008

A divided Federal Reserve yesterday sparked the strongest stock rally in five years by slashing interest rates another three-quarters of a percent in its most aggressive campaign in decades to revive the slumping economy.

The Fed cited major threats to growth, including job losses, a sharp decline in consumer spending and an intensifying housing and credit crisis that is threatening to bring down major banks. But in a nod to regional Fed presidents who objected to such a vigorous rate-cutting regimen, the Fed’s statement added that inflation remains a concern because of fast-rising prices for oil and other commodities.

Financial markets rejoiced over the Fed’s move — the latest in an unprecedented succession of rate cuts totaling two percentage points, discount loans and cash infusions into the credit and mortgage markets aimed at bolstering the depressed housing market, banks and brokerages.

The Dow Jones Industrial Average bolted 420 points higher, its biggest gain in five years, after making a similar move only a week ago after previous Fed actions.

“The Fed has finally intervened with overwhelming force,” said Ashish Shah, analyst at Lehman Brothers, one of the major investment banks that stood to gain the most from the Fed’s dramatic actions. A better-than-expected earnings report from Lehman helped provoke yesterday’s strong market rally.

“The regulatory authorities now understand that the time for half-measures is at an end,” Mr. Shah said. “Liquidity conditions had become dire. … The U.S. economy appears headed for recession,” but the Fed’s moves should serve to restore confidence, he said.

Markets initially pared gains on the Fed’s afternoon decision, reflecting hopes among many on Wall Street that the central bank was readying an even more gigantic full-point rate cut. But investors quickly got over their disappointment after contemplating the much improved outlook for Wall Street’s financial houses.

“The market accepted the decision without a big protest,” said Harm Bandholz, economist with UniCredit Markets, recognizing that the Fed is going all-out to bring the economy back to growth after what it hopes will be a mild recession in the first half of the year.

Earlier in the day, a Commerce Department report on home construction put “another nail in the coffin for the U.S. economy” by confirming that the housing downturn is intensifying after already posting the worst performance in 25 years in the latter half of 2007, he said.

“The Fed is very worried about the deepening of the housing recession,” which it ranks along with the credit crunch as the greatest threat to the economy, Mr. Bandholz said.

But the Fed’s extreme leniency since January has come at a price. “The risk of this approach is obviously that the Fed is running out of ammunition” after having reduced its main interest rate tool — the federal funds rate — to 2.25 percent, he said.

The funds rate governs short-term rates throughout the economy, including the prime rate, credit card rates and adjustable-rate mortgages. The Fed has rarely lowered it so far so fast in the face of rising inflation. “It seems the Fed is willing to take this risk — maybe because it has no other choice,” Mr. Bandholz said.

Fed Chairman Ben S. Bernanke and his colleagues on the Fed’s Board of Governors also risk further alienating several of the Fed’s 12 reserve bank presidents who are disgruntled over the seeming disregard for inflation and have spoken out against easy-money policies that they say could touch off a worsening of already troublesome inflation over 4 percent.

Philadelphia Reserve Bank President Charles I. Plosser added his name to the list of dissenters yesterday, voting against the big rate cut as too “aggressive” along with Dallas Reserve Bank President Richard W. Fisher.

“It is increasingly clear, and troubling, that they have decided to turn a blind eye toward the tumbling dollar and mounting inflationary pressures,” said Richard Yamarone, economist at Argus Research Corp. He said that short-term interest rates are now below zero when inflation is taken into account. The last time that happened was in 2003, when the Fed cut rates to 1 percent and set off the housing bubble that created today’s problems, he said.

“The Federal Reserve is now skating on dangerously thin ice,” Mr. Yamarone said, predicting that the “silly move” will backfire. Most businesses are having little trouble getting loans, so the big dose of rate cuts is overkill, he said. But he endorsed as “prudent” earlier Fed moves to provide loans and cash to banks to ensure liquidity in the financial system.

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