Wall Street wants Feds to cut rates

Friday, August 17, 2007

NEW YORK -- Financial markets to Federal Reserve: Cut rates ... now.

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 trying to force the Fed into giving them the interest rate cut they want -- and well ahead of the Fed's next meeting 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.

Rate cuts lower the costs of borrowing, making it cheaper for companies to do business and acquire rivals, and they make it less expensive for consumers to buy a home or pay off debt.

Derrick Wulf, a portfolio manager, said some investors balked at comments 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.

Investors' ire contributed to a 343-point plunge in the Dow during afternoon trading Thursday. The drop, which took the Dow more than 1,480 points below the highs it reached in mid-July, was almost completely wiped out when bargain hunters and people buying for technical reasons moved in -- but that doesn't mean Wall Street has passed the worst of the selling.

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 and now ordinary investors seeing their investments suffer.

"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," Clare said.

While he remains critical of the largely institutional investors such as hedge funds that have invested in subprime mortgages, he expects that if the stock market continues its overall downward trend, it would be very likely the Fed would step in with a rate cut.

So far, the Fed has only taken steps short of a rate cut to ease investors' pain.

The Fed and other central banks around the world in the last week have tried to lubricate the lending process and ease access to credit by injecting billions in funds into banks through a series of repurchase agreements. By announcing special "repo" agreements, the Fed has put more money into circulation and in essence lowered interest rates -- or at least kept them lower than they would otherwise be.

"I think the Fed so far has done the right things. They have not hit the panic button and cut rates. The traders are beating the drum for a Fed ease but in my opinion if you look at what the real problem is -- a freezing of the subprime market -- I don't think that would necessarily solve the problem," said Greg Hopper, portfolio manager at Julius Baer Investment Management LLC in New York.

"I think it would be a shotgun that would go quite wide at the target."

He contends investors could use a more nuanced approach, such as the Resolution Funding Corp., which Congress created in 1989 to selectively resuscitate some players in the savings and loan industry and liquidate others.

Some observers say the market has to force out investments that proved too risky.

"Access to liquidity by both consumers and businesses alike has not really been impacted that much by the short-term liquidity that the Fed has provided. That's what ultimately threatens the economy," Wulf said.

And if the Fed were to cut rates, it could risk sending inflation higher, something it would be loathe to do.

But the central bank has by many accounts become more adept at its job, having learned from its mistakes.

"In the past, say in the '50s, '60s and '70s, the Federal Reserve was perhaps responsible for a greater share of fluctuations in employment and in inflation than it is now," said Marvin Goodfriend, a professor of economics at Carnegie Mellon University and former policy adviser and director of research at the Richmond Fed.

"There is every reason to think at this point that the Fed and other world central banks have been making the right decisions so that this situation could calm down so that we could hopefully in the next several months go back to a place where the central banks fade back into the background."

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