Fed bolsters economy with bold half-point cut

Interest rate cut to 4.75%; Housebuilders' confidence depressed; Mortgage defaults up 115%
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The Independent Online

The Federal Reserve slashed US interest rates by half a percentage point yesterday in a bold move designed to restore confidence after the summer credit crisis and to prevent the crumbling housing market from infecting the rest of the economy.

The decision stunned the financial markets, which had expected a much more cautious quarter-point cut, sending US share prices soaring and handing the Dow Jones Industrial Average its biggest one-day gain since October 2002.

"The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally," the Fed explained in its accompanying statement. "Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time."

The decision was among the most anxiously awaited in recent history and a critical moment in the 18-month chairmanship of the Fed by Ben Bernanke. The cut takes the federal funds rate down from 5.25 per cent to 4.75 per cent, the first reduction in four years.

"The hope is that the shock of a 50-basis point rate cut will facilitate the return of reasonably priced credit to financially healthy borrowers," said John Lonski, chief economist at the credit rating agency Moody's. "The US economy is in need of an extraordinary change that might help to stabilise home sales."

Two new reports yesterday underscored the scale of the problems in the US housing market that the Fed is trying to control. A survey of housebuilders, carried out by their national trade body, found confidence at its lowest level since January 1991. And RealtyTrac, which monitors home repossessions, said the number of Americans facing foreclosure more than doubled in August compared to a year ago. It found foreclosure proceedings were in train against 243,947 homebuyers, up 115 per cent, as borrowers struggle to adjust to higher interest rates following the expiry of discounted "teaser" rates that were designed to lure them into a mortgage.

Wall Street has balked at funding any more of these risky mortgages, making refinancing all but impossible for some borrowers and piling additional downward pressure on house prices in many parts of the US. Evidence that the problems may be affecting the rest of the economy first emerged last month when the number of US jobs fell for the first time in four years.

The Dow Jones closed up 335.97 at 13,739.39 in a surge of optimism that the Fed's action will forestall a recession. Lower rates pushed the value of the dollar to a record low against the euro, and the weaker currency also helped feed price increases in dollar-denominated commodities such as oil, which touched $82 a barrel for the first time ever, and gold, which rose to a 27-year high.

The Fed was given an apparent green light to cut rates by the latest inflation data, out yesterday morning, which proved more benign than expected. The US producer price index showed a 1.4 per cent decline in August.

It was just six weeks ago that the Fed, at its last open market committee meeting, cited inflation as its number one concern, despite signs the credit crisis was threatening economic growth. The bias towards future interest rate tightening was abandoned two weeks later when the Fed cut the discount rate at which it lends to distressed banks, in a bid to restore liquidity to the credit markets. That discount rate was also reduced by 50 basis points yesterday.

The twin cuts allowed Mr Bernanke to upstage his predecessor, Alan Greenspan, who has been making high-profile public appearances to promote this week's publication of his memoir, The Age of Turbulence. He has denied inflating the housing market bubble by keeping interest rates too low for too long during his tenure. Hundreds of people lined up for Mr Greenspan's book signing at a Wall Street store yesterday, and the book has shot to the top of the Amazon charts.