Market plunge continues, despite Fed's new lending plan

WASHINGTON — The Federal Reserve took another bold step to boost troubled credit markets Tuesday as chairman Ben Bernanke hinted at another interest-rate cut to spark the U.S. economy and President Bush pushed foreign leaders for a global action plan to rescue banks.

Yet Wall Street was unmoved as all three major American stock indices lost another 5 percent of their value as financial market bloodletting continued.

The Dow Jones Industrial Average fell 508.39 points, or 5.1 percent, to close at 9447.11. The S&P 500 was off 60.66, or 5.7 percent, to 996.23. The Nasdaq finished down 108.08 points, or 5.8 percent, to 1754.88.

The Dow is down 13 percent in the past five trading days _ and down 33 percent from its all-time peak a year ago.

Speaking to business leaders in Virginia, Bush said his administration is moving at a breakneck pace to implement a bank rescue plan passed last week by Congress and urged companies to stay positive and take a "we can do it" attitude.

Earlier Tuesday, he phoned the leaders of Germany, France, Italy and Great Britain, trying to persuade them to take confidence-building actions similar to those in the U.S. Britain was receptive, but continental European Union members couldn't agree on a broad bank bailout plan and instead offered a token increase in deposit insurance. This added to the gloom on Wall Street.

While Bush played the role of comforter, Bernanke broadened the Fed’s emergency lending programs Tuesday morning. He then hinted in a lunch speech that more interest-rate cuts to spark the economy are coming — perhaps late this week at a meeting in Washington of the Group of Seven's finance ministers — or perhaps when the Fed's policy makers meet on Oct. 28-29.

"In view of the intensifying international dimension to the crisis, it would not be a surprise if a coordinated rate move were announced at G-7 meetings on Friday in Washington," said Peter Kretzmer, an economist with Bank of America, in a research note to investors that predicted a half-point cut from the current 2 percent to 1.5 percent.

The G-7 leading industrial democracies often try to coordinate policies. Members are the U.S., the United Kingdom, Canada, France, Germany, Italy and Japan.

Citing an easing of inflation threats and clear signs of a sharp slowdown in economic activity, Bernanke told the National Association for Business Economics that the Fed "will need to consider whether the current stance of policy seems appropriate."

Cutting the Fed's benchmark lending rate might lower borrowing costs for consumers and business, but the problem today isn't high rates; rather, it's the fact that banks can't or won't lend, and fear reigns in the world of finance.

To address the massive loss in confidence among lenders Bernanke moved before markets opened Tuesday to announce that the Fed would begin buying the short-term debt issued by major domestic and foreign corporations based in America.

The decision puts the Fed into another area traditionally outside its domain, backstopping corporations that are not in the banking sector. The action was prompted by the largest monthly drop ever, $153.5 billion in September, in a market once considered among the safest investments.

Big U.S. corporations such as General Electric, Caterpillar and other multinational companies issue commercial paper to raise money to pay for their inventory and cover payroll. This paper, as it's known, actually is a 30-day promissory note that works like an IOU. Until recently, such notes were snapped up by banks and money market funds.

But as the global credit crisis widened, banks weren’t willing to invest in commercial paper, preferring to ride out the growing financial storm by sitting on cash instead of lending it. In the last three weeks alone, the commercial-paper market has shrunk by more than $200 billion.

So, using its authority as the lender of last resort, the Fed said it would buy commercial paper from corporations and do so through April 30, 2009. The Fed’s action was open-ended, meaning it will be based on demand and without a fixed price tag on it.

"The Federal Reserve's move should go a long way toward unlocking the commercial-paper market. It had become too clear the strategy of providing reserves to banks with the hope those banks would lend to each other and to corporate borrowers had failed," said Howard Simons, an investment strategist for Bianco Research in Chicago. "The Federal Reserve, by lending directly, has removed the very real possibility that large high-quality corporate borrowers might have had to close down operations for lack of short-term liquidity."

Normally, commercial paper is rolled over, meaning investors keep it instead of cashing it in after 30 days. But the worsening credit situation has meant that little commercial paper is being purchased and whatever is rolled over is refinanced at much higher lending rates that raise business costs for corporations and thus threaten American jobs.

"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 again engage in term lending in the commercial paper market," the Fed said in a statement. "Added investor demand should lower commercial paper rates from their current elevated levels and foster issuance of longer-term commercial paper."

The Fed's Commercial Paper Funding Facility will purchase 30-day commercial paper from both U.S. corporations and the U.S.-based operations of foreign companies. It also will purchase what's called asset-backed commercial paper, whose collateral is actually assets that could be seized if a corporation defaulted on its loan.

For corporate debt not backed by a fixed asset, the Fed will require some up-front fees to guard against default. It will only purchase commercial paper with strong ratings from credit-rating agencies.

In his lunch speech, Bernanke defended a long string of aggressive Fed moves as necessary given "a problem of historic dimensions" and because delay would only make things worse.

"We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased," he said.

In other economic developments Tuesday:

  • For the first time in a decade, the rate of consumer borrowing fell. The Fed reported that consumer credit outstanding for a 12-month period ending in August fell 3.7 percent. It underscored the pressure building on family budgets across America.
  • The Energy Information Administration said Tuesday that residential home heating with natural gas will be 11 percent more expensive this winter, and 29 percent more costly for users of home heating oil.
  • The director of the non-partisan Congressional Budget Office estimated that the retirement savings of ordinary Americans have lost about 20 percent of their value since the middle of last year. Peter Orszag said Americans with 401(k) retirement plans were hit hardest because these plans favor stocks.
  • The Federal Deposit Insurance Corp. proposed a sharp increase to the assessment rate that banks pay in the form of premiums to help cover the cost of insuring bank deposits.
  • Four federal bank regulators Tuesday night issued a statement saying they propose relaxing the way they view risk in mortgage finance giants Fannie Mae and Freddie Mac, since the two were seized by the federal government on Sept. 6 and now enjoy explicit government backing.

    Bernanke's speech

    The Fed's statement

    Fed consumer-credit data

    EIA winter energy outlook

    Bank regulator' proposal to relax rules


    In pricey Greenwich, Conn., signs of a troubled economy

    Citigroup, Wells Fargo negotiating on how to split Wachovia

    Dow closes at 4-year low as crisis mood sweeps the world

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