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Letter to the editor

Fed opens credit's faucet

Its interest rate cut sends stocks soaring as data show a troubling foreclosure trend.

By HELEN HUNTLEY, Times Personal Finance Editor
Published September 19, 2007

The Federal Reserve acted aggressively Tuesday, cutting short-term interest rates twice as much as investors and analysts expected. Fed governors are more worried about problems in the credit market, which have hurt the already crippled housing market, than they are about prospects for inflation.

The slash sent shock waves of delight through the financial markets. Stocks soared, with the Dow up nearly 336 points, while the dollar sank in response to the first rate cut in four years by the nation's central bank.

"Clearly what matters to them more than anything is what's going on in the credit markets," said Scott Brown, economist for Raymond James & Associates in St. Petersburg. "The longer the problems last, the greater the downside risk to growth and they're responding in a big way."

Indeed, the Fed's decision to cut rates occurred on the same day that new housing data showed a doubling of foreclosure filings last month compared to August 2006. The pace of Florida's foreclosure filings was third only to Nevada and California.

Investors' focus was on the size of the Fed's cut, a half percentage point instead of the quarter point that was widely anticipated. The federal funds rate, the rate at which banks lend each other money overnight, went from 5.25 to 4.75 percent.

That cut prompted other interest rate cuts. Big banks immediately began cutting their prime rates, a benchmark for other interest rates. In the coming weeks, borrowers may benefit from lower rates on home equity credit lines, adjustable rate mortgages and credit cards. But savers can expect to see lower rates on CDs and money market funds.

"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 Fed said in a statement.

The underlying problem is that mortgage defaults and fears of more to come have paralyzed the market for certain types of mortgage-backed securities. As part of the fallout, many lenders have stopped making loans to borrowers who have impaired credit or can't document their income. That's been a blow to the housing market, which was already suffering, and created concerns that the situation could evolve into a broader credit crunch.

The Fed statement noted that "tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally."

For some market watchers, the Fed's stance was puzzling in light of Fed Chairman Ben Bernanke's previous statement that it wasn't the Fed's job to protect lenders from the consequences of their decisions. That seemed to indicate the Fed would take a more measured course.

"Today's move was inconsistent with everything else Bernanke has done," said St. Petersburg money manager John Carlson of Doyle Wealth Management. "The market's reaction is telling you most people did not expect it."

Stocks took off, with the Dow Jones Industrial Average soaring 335.97 points, a gain of 2.5 percent, to close at 13,739.39.

Tampa investor Thomas Blackburn was one of those smiling at the results.

"I really took a hit last month and today helped out a lot," he said after the market closed. The retired meteorologist said the rate cut probably will cut the income he earns on his money-market fund, but his stock market gains more than made up for those future losses.

In addition, he said he has benefited from Tuesday's decline in the dollar and the increase in the price of oil because he owns Canadian oil and gas stocks. "I feel kind of guilty doing this, getting money off the miseries of the U.S. dollar."

The Dollar Index, which measures the dollar against six major currencies, hit its lowest level in 15 years Tuesday. Lower interest rates make the U.S. financial markets less attractive to foreign investors. That in turn makes it more expensive for Americans to travel abroad or buy foreign products.

Oil prices hit a new high, climbing above $81 a barrel, which means inflation risks remain. The Fed indicated it will continue to monitor conditions and could cut rates again next month if it doesn't think conditions have improved.

Helen Huntley can be reached at hhuntley@sptimes.com or (727) 893-8230.

[Last modified September 19, 2007, 00:27:45]