Fed Cuts Funds Rate By Half-Point Federal Reserve policymakers cut the key federal funds as instability in the financial markets and the mortgage industry meltdown has dramatically increased recession concerns.
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Fed Cuts Funds Rate By Half-Point

U.S. Federal Reserve Chairman Ben Bernanke speaks before the National Italian American Foundation in New York in a file photo from 2006. Stan Honda/AFP/Getty hide caption

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Stan Honda/AFP/Getty

U.S. Federal Reserve Chairman Ben Bernanke speaks before the National Italian American Foundation in New York in a file photo from 2006.

Stan Honda/AFP/Getty

Federal Reserve policymakers announced Tuesday a half-point cut in the key federal funds rate to 4.75 percent, the first such reduction in four years.

The announcement came as a surprise to many economists, most of whom predicted only a quarter-point drop. The move comes as the Fed Chairman Ben Bernanke signaled a willingness to do whatever is necessary to bridge instability in the credit markets.

Tuesday's meeting was the first in more than four years to produce a lower funds rate. It comes in the midst of the worst slump in housing in 16 years. That downturn has triggered record defaults in subprime mortgages and roiled financial markets around the globe as investors have become worried about where the spreading credit problems will next appear.

In the minutes after the announcement, the Dow surged by more than 100 points, after already trading solidly higher in anticipation of a rate cut.

A change in the funds rate, which stood at 5.25 percent before the announcement, is reflected immediately in banks' prime lending rate, the benchmark for millions of consumer and business loans.

Most economists had predicted that Bernanke and his colleagues would reduce the rate by only a quarter point, although a few economists foresaw the chance of the bolder half-point move.

The cut could prove to be a boost to people such as yacht broker John Purinton, who sells sailboats and power boats from a marina in northern New Jersey.

From his office, Purinton can see the imposing skyline of Wall Street just across the Hudson River. Like the bankers and traders in those towers, Purinton is closely following the Fed's action on interest rates.

"If interest rates get cut, the fall boat season will be a heck of a lot better than if they're not," he said.

Purinton said a lot of people buy boats on credit. Often they do so by getting second mortgages on their homes. So the question of whether the Fed lowers interest rates on Tuesday — and by how much — is a practical concern for him.

"Some folks think a quarter point will kind of stem the flow and a half point will start to reverse things," he said. "Obviously, either are going to be great for us because when you're talking about a $300,000 loan, a half point is huge and a quarter point is nothing to bat your eyelashes at either."

Chris Varvares is president of the research firm Macroeconomic Advisers. Until recently, Fed policymakers have kept interest rates firm so as not to fan the flames of inflation. But on Aug. 16, they reversed course, cutting one of the two interest rates they control and suggested they were ready to cut the other, too. They issued a statement saying they had grown worried about what they called the downside risks to the economy.

"It really set up expectations in the market that the Fed would be cutting rates at the next opportunity," Varvares said.

He said the Fed changed course because of the problems in the prime mortgage market. With losses mounting, investors no longer wanted to put money into the mortgage business. A lot of lenders were forced out of business and the downturn was spreading to other kinds of credit.

Some businesses found it harder to borrow money.

Economist Louis Crandall of the research firm Wrightson ICAP said there is a lot of uncertainty in the economy right now.

"We know there are sub-prime losses out there. We don't know exactly where they reside and so anyone potentially at risk of sub-prime losses is having trouble attracting funding right now," Crandall said.

In times like these, interest-rate cuts can act as a confidence builder, he said.

"Even if they don't directly address what's going on, they provide a comfort level and they are the most visible reminder a central bank can provide ... that (they) are ready to prevent a problem from spreading," he said.

Economists said they believed that Bernanke, who wrote extensively as an economics professor on the Great Depression that followed the 1929 stock market crash, understands what needs to be done to avert downturns.

"We have had a long history of financial panics and if we have learned anything, it is that you shove money at them," said David Wyss, chief economist at Standard & Poor's in New York, told The Associated Press.

While some have complained that Bernanke has been more tentative than his predecessor would have been — no less an authority than Greenspan disagrees.

Doing a round of interviews to promote his new book, Greenspan, who was Fed chairman for 18½ years, said Bernanke was "doing an excellent job" and he doubted that he would have done anything differently.

Greenspan told the AP that the odds of a recession have grown since earlier this year, even though "the economy is not doing badly at this stage."

He put the odds of a recession at greater than one in three. "But best I can judge it is less than 50 percent," he said.

Greenspan's one-in-three prediction earlier this year rocked Wall Street.

From NPR reports and The Associated Press