A healthier economy might spur business activity and keep a lid on loan losses. A Commerce Department report Wednesday showed surprisingly brisk 3.9 percent annualized economic growth from July to September, the highest in 1-1/2 years.
But the Fed said this rate will likely slow, "partly reflecting the intensification of the housing correction."
"Rate cuts don't cure past mistakes," said Gary Townsend, a banking analyst at Friedman Billings Ramsey & Co. in Arlington, Va. "To the extent banks have not lent wisely, such as in subprime mortgages or some residential construction in Florida, those loans may already be bad now."
Moreover, some banks, including Citigroup, Bank of America and Wachovia, have large capital market exposures, and were hurt this summer when that market seized up.
Morgan Stanley's Betsy Graseck on Wednesday downgraded the sector to "cautious" from "attractive," and projected a "consumer credit recession" in 2008. She also downgraded Citigroup, Bank of America and Wells Fargo.
"We expect significant deterioration as tighter credit standards, imposed by banks and capital markets, squeeze consumers and as unemployment rises and housing values fall," Graseck wrote. "We see further downside risk to earnings per share if a consumer credit recession spills into corporates."
On top of this, banks such as BB&T in the southeast and Commerce Bancorp in the mid-Atlantic have lamented growing competition for deposits.
Countrywide Bank, for example, Wednesday offered a 5.65 percent yield on a $10,000, six-month certificate of deposit.