As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates — perhaps to their lowest point in more than four years — with the hope of relieving some of the pain felt by many Americans.
WASHINGTON — As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates — perhaps to their lowest point in more than four years — with the hope of relieving some of the pain felt by many Americans.
The convergence of a housing collapse and a lockup in lending has created the worst financial crisis in more than a half-century. Former Chairman Alan Greenspan, who ran the Fed for 18 ½ years, called it a “once-in-a-century credit tsunami” and conceded he made mistakes that may have aggravated the economy’s slump.
With a recession seen as inevitable, if not under way, any rate cut would be aimed at cushioning the fallout.
Vanishing jobs and shrinking paychecks have forced consumers to cut back sharply. Millions have watched their 401(k)s and other nest eggs shrink and the value of their homes drop, making them feel in even worse financial shape.
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In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.
“These are sobering times,” said Paul Kasriel, chief economist at Northern Trust.
All the problems have been feeding on each other. So far, Fed Chairman Ben Bernanke and his colleagues haven’t been able to break the vicious cycle, despite hefty rate reductions and unprecedented steps aimed at getting credit flowing more freely again.
Bernanke says he’ll use all tools to battle the crisis.
To that end, Fed policymakers are widely expected to lower the central bank’s key interest rate at the conclusion of a two-day meeting Wednesday — their last session before the November elections.
Investors and some economists predict the central bank will drop the rate by half a percentage point to 1 percent. If that happens, it would mark the lowest rate since the summer of 2004. Others, however, think the rate will be cut by a smaller, quarter-point to 1.25 percent.
In turn, rates on home-equity, certain credit cards and other floating-rate loans tied to commercial banks’ prime rate should drop by a corresponding amount
A half-point reduction would leave the prime at 4 percent; a quarter-point cut would drop it to 4.25 percent.
Either way, the prime rate would be the lowest in more than four years.
The Fed hopes lower rates will spur people and businesses to spend again, helping to brace the wobbly economy.
“I think it would be a good-faith psychological move,” said Richard Yamarone, economist at Argus Research. However, he and others doubt another rate reduction will entice people — many buried under piles of debt — to ramp up spending. But it might help a little, they said.
Bernanke has repeatedly warned that the country’s economic weakness could last for some time, even if the government’s unprecedented $700 billion bailout package and other steps do succeed in getting financial and credit markets to operate more normally.
Many expect the unemployment rate — at 6.1 percent — to hit 7.5 percent or higher by next year. Employers have cut jobs each month this year. A staggering 760,000 jobs have disappeared.
Kasriel thinks another rate reduction could help squeezed banks.
Lowering rates would increase the difference between the rate banks charge each other to borrow overnight and the rates they are paid on investments in super-safe Treasury securities, a popular investment these days given the chaos in credit markets and on Wall Street, Kasriel said.
“That will improve profits and will enable banks to restore their capital,” he said.
To unclog credit, the Treasury Department recently announced a historic step, saying it would inject up to $250 billion into banks in return for partial ownership.
The hope is that banks will use the capital infusions to rebuild their reserves and boost lending to customers.
The money also can be used by a bank to buy another bank, strengthening both to better weather the financial storms.