MercoPress. South Atlantic News Agency

Fed next move to unclog financial system: lower rates

Ben Bernanke the expert in the 1929 crisis never expected October 2008

Faced with worst economic and financial market crisis since 1929, Federal Reserve Chairman Ben Bernanke on Tuesday sent a strong signal that officials may lower interest rates against a backdrop of waning price pressures.

"The combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased" while the price outlook has "improved somewhat," Mr. Bernanke said in prepared remarks to the National Association for Business Economics. "In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate," he said. The Federal Open Market Committee is scheduled to meet October 28/29. Through midyear, resilient consumer spending and robust growth in exports kept the economy afloat despite the severe housing slump and credit crunch. But the economy has buckled since the summer -- the latest evidence being a 159,000 drop in non-farm payrolls last month and a sharp decline in the Institute for Supply Management's September manufacturing index to levels not seen since the 2001 recession. "All told, economic activity is likely to be subdued during the remainder of this year and into next year" Mr. Bernanke said, and financial strains "may well lengthen the period of weak economic performance and further increase the risks to growth". Bernanke noted that consumer spending, adjusted for inflation has "contracted significantly" since May while weakening sales and heightened uncertainty "have begun to weigh more heavily on investment spending as well". Against that backdrop, "continued efforts to stabilize the financial markets are essential," he said, noting that market instability and asset price declines "can take a heavy toll on the broader economy if left unchecked." With inflation likely to moderate in response to the steep drop in oil prices since July, a growing number of Wall Street economists now expect the Federal Open Market Committee to lower interest rates later this month after a five-month pause with the target fed-funds rate at 2%. Some economists are even calling on the Fed to revisit 2003 lows on the fed-funds rate at 1%. Mr. Bernanke remarks Tuesday appear to support that view. Though inflation "has been elevated," Mr. Bernanke said falling oil prices, steady inflation expectations and the economic slowdown "should lead to rates of inflation more consistent with price stability." Earlier Tuesday, the Fed announced another new initiative aimed to unclogging short-term credit markets. Under the Commercial Paper Funding Facility, the Fed would purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The goal is to restore confidence by eliminating the risk that issuers of commercial paper will not be able to repay investors. The Fed is already in un-chartered waters with other programs like the Term Auction Facility, primary dealer credit facility, money market mutual fund loan backstop and loans to Bear Stearns and American International Group Inc. As a result of those and other steps, borrowing from the Fed as of last Wednesday stood at over 400 billion US dollars, shattering previous records. While Mr. Bernanke said he believes the private sector should address market difficulties when possible, "in those cases when financial stability is threatened...intervention to protect the public interest may well be justified." "So long as financial conditions warrant, we will continue to look for ways to reduce funding pressures in key markets," he said. Commenting on recent legislation enabling the Fed to pay interest on bank reserves, Mr. Bernanke said the tool will allow officials to "better control the federal funds rate" by setting a floor in it. "We will begin exercising that authority this week," Mr. Bernanke said. As for the Treasury Department's program to purchase up to $700 billion in illiquid mortgage backed securities, which was approved by Congress last week, Mr. Bernanke said Treasury will "be a patient investor and will likely hold these assets for an appreciable period of time." If the program, known as TARP, "promotes financial stability, leading ultimately to stronger economic growth and job creation, it will have proved a very good investment indeed, to everyone's benefit." Mr. Bernanke also said negotiations are continuing on the purchase of Wachovia Corp., Citicorp Inc. and Wells Fargo & Co. have each made bids on the troubled bank. "Most importantly, however, in either case all depositors and creditors of Wachovia are fully protected, and depositors and other customers will experience no interruption in banking services," he said.