Moves by Fed, Europeans Fail To Calm Investors

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Bernanke: More Economic Pain Ahead

Federal Reserve Chairman Ben Bernanke warned Tuesday that the financial crisis has not only darkened the country's current economic performance but also could prolong the pain.

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In his speech yesterday afternoon, Bernanke indicated that the Fed could cut interest rates soon to try to shield the economy against the fallout from the financial crisis. Prices in futures markets indicate that investors are nearly certain rates will be cut at the Fed's Oct. 28-29 policymaking meeting, if not before.

The combination of recent sour economic data and the crisis "suggests that the outlook for growth has worsened and that the downside risks to growth have increased," Bernanke told the National Association for Business Economics yesterday. As a result, the central bank "will need to consider whether the current stance of policy remains appropriate," a clear sign that rate cuts are on the table.

Under Bernanke, the Fed has cut rates between regularly scheduled meetings just once, this past January. But Bernanke used milder language yesterday than he did in an early January speech that foreshadowed that cut, suggesting there is no certainty the Fed will move as quickly and aggressively as many Wall Street analysts are forecasting.

In particular, some Fed leaders have indicated in speeches that they think that rate cuts won't have their intended impact -- of lowering borrowing costs and thus stimulating the economy -- so long as world credit markets remain a mess. And they worry that the price of oil has been so volatile lately that rate cuts could end up hurting Americans' purchasing power by driving the price of oil up and the value of the dollar down.

The financial crisis strikes at the heart of Americans' ability to continue buying the things they need, Bernanke said in his speech.

"Even households with good credit histories are now facing difficulties obtaining mortgage loans or home-equity lines of credit," Bernanke said. "Banks are also reducing credit card limits, and denial rates on automobile loans reportedly are rising."

Offering fresh evidence of the depth of the problem, the Fed released data yesterday indicating that the amount of consumer debt Americans have outstanding had its first monthly decline in a decade in August. And that was before the credit crisis deepened in September and October.

Although a rate cut would be aimed at encouraging overall economic growth, the new Fed action on commercial paper is designed to get more at the nub of the problem, a crisis of confidence among banks and other lenders.

The Fed is using emergency authority it was granted during the Depression to lend to any "individual, partnership or corporation" in "unusual and exigent circumstances." It used that authority two other times this year -- to rescue Bear Stearns and take over American International Group. This time, for the commercial paper program, the Treasury Department will help provide funding.

In previous lending programs this year, the Fed has loaned only against strong collateral. But now the Fed will even take on "unsecured" debt, or that which is backed only by the faith of the company borrowing money. It will require insurance fees on companies borrowing money with unsecured debt to protect against losses.

Critically, the Fed will buy debt that is for three-month terms. Lately, a wide variety of companies have been able to borrow money only overnight. That has put them in a precarious position of having their fates decided every evening, as lenders must again review whether to renew the loans.

By having the government ready to buy slightly longer-term debt, that uncertainty should be diminished, Fed officials are hoping.

The Fed entity will pay interest rates that are lower than the extremely elevated rates of recent days, but still higher than what the companies could borrow at in normal times. That way, once financial conditions return to normal, the companies needing money will naturally migrate back to private markets so as to get lower borrowing costs.

"It seems like the program is well designed to allow the normal functioning of the commercial paper market to resume," said Matus, the Merrill Lynch economist.

In the speech yesterday, Bernanke for the first time defended his decision not to intervene to save Lehman Brothers, the investment bank that filed for bankruptcy protection last month, helped trigger a worsening of the crisis.

It boils down to: The Fed had little choice.

"We determined that either facilitating a sale of Lehman or maintaining the company as a free-standing entity would have required a very sizable injection of public funds -- much larger than in the case of Bear Stearns -- and would have involved the assumption by taxpayers of billions of dollars of expected losses.

"Neither the Treasury nor the Federal Reserve had the authority to commit public money in that way," Bernanke said. He drew a contrast with the Bear Stearns and AIG bailouts, in which the Fed made loans that it fully expects to be paid back.