Fed Signals Fresh Rate Cut to Calm Markets The Federal Reserve and the Bush administration are trying to reassure investors worried about the worsening crisis in the credit and housing markets, sending strong indications that another rate cut is on the horizon.
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Fed Signals Fresh Rate Cut to Calm Markets

David Wessel, economics editor of The Wall Street Journal

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The Federal Reserve and the Bush administration are trying to reassure investors worried about the worsening crisis in the credit and housing markets, sending strong indications that another rate cut is on the horizon.

They are promising to be nimble about making cash available to the financial system and are urging lenders to do all they can to prevent home foreclosures.

On Thursday, Federal Reserve Chairman Ben Bernanke hinted that another cut in interest rates is in the offing when the Fed meets Dec. 11.

Unfavorable economic conditions such as the worsening credit crunch, a deepening housing slump and rising energy prices are likely to create some "headwinds for the consumer in the months ahead," Bernanke said in a speech to business leaders in Charlotte, N.C.

Wall Street was encouraged by that observation Friday and bid up shares on the New York Stock Exchange.

Bernanke said he expects consumer spending to continue to grow and suggested that a recession can be avoided, but Fed policymakers will need to be "exceptionally alert and flexible."

The Fed last cut rates Oct. 31, lowering the federal funds rate — charged on overnight loans between banks — a quarter-point to 4.5 percent. That cut followed one on Sept. 18 that lowered borrowing costs by a half-point.

Bernanke's comments came a day after similar remarks by Fed Vice Chairman Donald Kohn, and just hours after the White House lowered its economic growth projection for 2008 due to the deteriorating housing market.

Consumers Take Caution

Consumers are already showing unease over economic prospects. Consumer spending nudged up 0.2 percent in October, the Commerce Department reported Friday; and a 0.2 percent rise in individual incomes marked the poorest showing in six months.

Earlier this week, the Consumer Confidence Index dropped to 87.3 for November, down nearly eight points from the revised 95.2 in October. The drop was the lowest in two years, according to the New York-based Conference Board.

Meanwhile, the Bush administration is maneuvering behind the scenes on a plan with the industry to extend the lower introductory interest rates on home loans before they reset to higher levels.

Treasury Secretary Henry Paulson and other top regulators met Thursday with loan-servicing companies, investment firms and banks. An agreement could be revealed as early as next week.

"We've all agreed that there should be some sort of standardized approach to reaching more homeowners faster," said Treasury Department spokeswoman Jennifer Zuccarelli, who declined to name those at the meeting.

The number of homeowners who fell behind on mortgage payments or lost their homes last month nearly doubled. Some 224,451 foreclosure filings were reported in October, up 94 percent from 115,568 in the same month a year ago, according to Irvine, Calif.-based RealtyTrac Inc. Filings include default notices, auction sale notices and bank repossessions.

Lending Tightens

Spikes like these illustrate the calamity befalling the credit and housing markets. Lenders now have a tighter grip.

"These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors," Bernanke said.

"Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy," he added.

Critics blame defaults on lenders. They say borrowers are struggling to pay their loans because banks and other lenders were too freewheeling. Further, they say consumers were given subprime loans — offered to those with weak credit — with adjustable interest rates too easily. And they were ill-informed about the risk of the loan resetting to a too-high rate.

Consequently, consumers weren't the only ones caught. Many lenders, including Merrill Lynch, Countrywide Financial and Citigroup, were exposed to billions of dollars in defaults and had to take enormous losses. They also had to endure intense ridicule from lawmakers and activists for their chicanery; and they are now under pressure to reassess borrowers' loans to stave off foreclosure.

Another rate cut by the Fed could make it easier for them to comply faster. Likewise, borrowers are likely to be more willing to take on more debt at a lower cost, especially businesses.

Take the construction sector, for example. It tends to borrow huge amounts to build homes and commercial entities. But it, too, has had to pull back. Construction spending fell by 0.8 percent last month, the biggest decline since July, according to the Commerce Department. Activity in the besieged housing industry fell by 2 percent — its 20th consecutive slide.

Private nonresidential construction, which previously had mitigated the housing slide, dropped by 0.5 percent. It was the sector's first decline in 13 months. The only strength was in government activity, which rose 0.8 percent as spending on state and local projects hit an all-time high.

From NPR reports and The Associated Press