Fed Looking at Another Rate Cut to Stem Crisis

John Pettiford, left, helps Maria Toledo search for a job at the Arlington Employment Agency. Forecasters say the jobless rate could hit 10 percent before good times return.
John Pettiford, left, helps Maria Toledo search for a job at the Arlington Employment Agency. Forecasters say the jobless rate could hit 10 percent before good times return. (By Kevin Clark -- The Washington Post)
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By Neil Irwin
Washington Post Staff Writer
Tuesday, December 16, 2008

The Federal Reserve is widely expected this afternoon to cut interest rates for the 10th time in just over a year, driving the rate it controls close to zero as it continues the most sweeping effort to stabilize the economy in the history of the central bank.

The federal funds rate, at which banks lend to each other, is already at 1 percent. The Fed is expected to drop it to half a percent, or even lower, at the end of its policymaking meeting today. That would be the lowest U.S. rate on record.

Rate cuts, however, are not having the same impact that they normally have. Given the meltdown in world credit markets, no matter how low the rate goes, lenders are not passing the cuts to their customers.

As a result, the Fed is using every tool in its arsenal -- many of them newly invented -- to try to contain the damage of the financial crisis and steep economic downturn. Today, it may signal that it will further expand its unconventional lending programs, which already amount to about $2 trillion.

Since World War II, the nation has experienced 11 recessions, including the current one. Those downturns have had various causes -- too much inventory on businesses' books, for example, or the popping of a stock market bubble -- and rate cuts have routinely helped the economy get back on its feet.

This a more virulent downturn, with a simultaneous bursting of a global lending bubble, especially involving U.S. home mortgages. The result has been a breakdown in the credit flow of a sort that has historically occurred only in the rarest and most profound crises. By responding quickly and aggressively, the Fed is trying to avoid repeating the mistakes that policymakers have made in the past.

"Make no mistake, this is not a garden variety recession of the sort we've seen since World War II, when there were excessive manufacturing inventories or inflation or central bank tightening," said David Rosenberg, chief North American economist at Merrill Lynch. "We're all flying blind."

In 2001, there was a correction of the technology stock bubble and over-investment by businesses in the 1990s. Thanks in part to aggressive Fed rate cuts, it was a mild recession.

In 1990-91, a bubble in commercial real estate popped and savings and loans failed in vast numbers, but the breakdown in credit was mostly contained to those sectors.

The 1981-82 recession was the most severe of the post-World War II era, but was caused by the Federal Reserve, which aggressively raised interest rates to try to end the high inflation of the 1970s.

This downturn, by contrast, features the bursting of a mortgage lending bubble, a home price bubble, a consumer spending bubble, a commercial real estate bubble, and a corporate lending bubble. It has already brought down several of the world's largest financial companies, and many more would have gone under if it weren't for extraordinary government interventions to prop them up.

Part of what worries economists about this recession -- and makes them think that it could rival the 1981-82 recession in severity -- is the speed with which it has worsened in recent months.

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