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Fed cuts rates boldly; Wall Street wary

(Agencies)
Updated: 2008-01-31 06:50

In the gravest challenge to his leadership since becoming Fed chief nearly two years ago, Bernanke must help stem the fallout from both the housing bust and a credit crunch. Wall Street critics and others have taken Bernanke to task for waiting until September of last year to embark on a rate-cutting campaign, accusing the Fed chief of being behind the curve in dealing with the economy's problems.

Bernanke also must be mindful of not letting inflation get out of hand - a delicate and tricky maneuver. Oil prices have receded from $100 a barrel but still remain high. The Fed said it expects inflation to ease in coming quarters but added that it is imperative to monitor developments carefully.

Still, more rate cuts are expected at the Fed's next scheduled meeting in March and beyond. Some economists predict the key rate could drop as low as 2 percent this year, which would be the lowest in four years.

"The Fed needs to throw out a life raft to the economy pending the fiscal stimulus measures," said Brian Bethune, economist at Global Insight.

Even further action might not avert a recession but rather limit the damage. The interest rate cuts will take months to affect the economy, as will any stimulus package approved by the government. Neither effort will quickly cure the root cause of the economy's troubles: a severely depressed housing market and bad mortgage investments.

The economy may actually be declining now. Under one rough rule, it would have to contract for six months in a row for the country to be considered in a recession. The likelihood of a recession has risen sharply over the past year, and analysts increasingly believe the US will be in one during the first half of 2008. The worry is that people and businesses, which turned more cautious at the end of the year will hunker down, sending the economy into a tailspin.

Bernanke is not expected to cut rates as deeply as did his predecessor, Alan Greenspan, when Greenspan took on the 2001 recession, the economic fallout of the Sept. 11 attacks, a series of accounting scandals that rocked Wall Street and the uncertainty that gripped the country leading up to the U.S.-led invasion of Iraq in March 2003.

By the summer of 2003, Greenspan had slashed rates to 1 percent, a 45-year low. He held rates there for a year before the Fed began pushing them back up.

Critics contend those low rates helped feed a housing frenzy, in which home values zoomed and investors gobbled up risky loans, known as subprime mortgages, to borrowers with poor credit histories. When the housing market collapsed, the greatest damage was in subprime loans. Banks and other financial institutions have taken big hits on these soured mortgage investments.

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