The US Federal Reserve, declaring that increased economic uncertainty poses risks for US business growth, announced yesterday that it has approved a half-percentage point cut in its discount rate on loans to banks.
The action was the most dramatic effort yet by the central bank to restore calm to global financial markets which have been roiled in the past week by a widening credit crisis.
The decision means that the discount rate, the interest rate that the Fed charges to make direct loans to banks will be lowered to 5.75 percent, down from 6.25 percent.
The Fed did not change its target for the more important federal funds rate, which has remained at 5.25 percent for more than a year.
With worries about credit taking the Dow Jones industrials down by sometimes hundreds of points a day the past few weeks, investors seem to be have been trying to force the US central bank into giving them the interest rate cut they want -- and well ahead of the Federal Reserve's next meeting on Sept. 18.
In good times, it's not readily apparent to the casual observer that the central bank is actually one of the biggest underpinnings of the stock market. But when the market is squeezed and wants help, it is often the Fed that gets the call for some sort of lifeline.
Derrick Wulf, a portfolio manager, said some investors balked at comments on Thursday from St. Louis Federal Reserve president William Poole that the central bank wouldn't need to intervene in the stock market short of a calamity.
"Some people's reaction to that was `You want a calamity, you'll get a calamity,'" said Wulf, who works at Dwight Asset Management Company in Vermont.
Whether the market's drop since last month is viewed as a healthy pullback from new highs that came too quickly or the start of a broader retrenchment, some analysts contend a rate cut by the Fed would mean the bank was acquiescing to investors burned by risky bets. Many of the investments they made that are now regarded as questionable are made up of mortgages from borrowers with weak credit that were bundled together and sold off to investors. But the concerns about failing subprime loans have spilled beyond that sector of the market, making access to credit more difficult for everyone.
"The equity market seems to be pushing the Fed at the moment," said Andrew Clare, a professor of asset management at London's Cass Business School.
"I don't think the Fed should have to come in and bail out those institutions that were lax. Otherwise, that creates a tremendous moral hazard," said Clare, a former analyst at the Bank of England.