Economy

Fed Keeps Altering Tactics As Credit Crisis Deepens

This is all uncharted territory--even for the Federal Reserve.

Credit Crunch
CNBC.com

As the credit crunch spins faster and louder, the central bank is becoming bolder and more imaginativethan ever in its tactics. But given the lack of precedence, the outcome may be hard to predict.

The Fed’s decision Sunday to allow non-banks to borrow funds through a version of its discount window is "an historic thing," former Dallas Fed president Robert McTeer told CNBC.

The move, which was accompanied by a quarter point cut in the discount rate that narrowed its traditional half-a-point spread with the federal funds rate, is the latest sign the central bank has been in something resembling crisis management for more than a week.

“The Fed is really worried," says Robert Brusca, chief economist at Fact And Opinion Economics, adding that the Fed-assisted Bear Stearns fire sale to JPMorgan Chase“suggests the threat of a radical repricing of assets.”

Next for the Fed is another major cut in lending rates at its regularly scheduled FOMC meeting on Tuesday.

Wall Street is now betting on a full-point cut in the federal funds rate, to 2 percent, putting the key lending rate indisputably below key inflation gauges. Another cut in the discount rate is also expected.

Such circumstances are not without precedent and the Fed even said as much in its January FOMC minutes.

In the 1990-1991 recession, says economist Christopher Rupkey, the Fed made a full-point cut in its discount rate — then its major rate policy tool — putting it below the inflation benchmark of the time.

“The outsized move was successful at stabilizing market confidence,” says Rupkey of the Bank of Tokyo-Mitsubishi.

At this juncture, Fed policy may have as much or more to do with confidence than market conditions and economists are divided over its chances for success.

McTeer says the probem isn't about the level of interest rates. “The discount rate is the way to deal with crises," he adds, and the Fed's decisions Sunday support that view.

Economists generally agree, saying that a lower federal funds rate will at best help struggling financial firms on the margin avoid bankruptcy.

After all, the Fed has been cutting rates for six months now with little arguable effect on the credit crunch, prompting more than a few economists to question its utility as well as negative side effects.

“I don’t think the Fed is going to be worried about inflation or the dollar. The Fed is worried about getting through this crisis without big bank failures,” says McTeer.