GREENSPAN ORDERS INTEREST RATE CUT

Federal Reserve Chairman Alan Greenspan, in a surprise move yesterday, ordered short-term interest rates cut by a quarter-percentage point, an action intended to restore stability to chaotic financial markets and reduce the risk of a recession in the United States next year.

Greenspan and other top Fed officials have said that turmoil in the stock, currency and bond markets has become so intense that it poses such a risk. By cutting rates for the second time in less than a month, the central bank indicated it will supply enough cash to the nation's banking system to make sure that hard-hit markets for corporate bonds, mortgage-backed securities and other such investments begin to function smoothly once more, analysts said.

Financial markets are so disturbed, numerous economists said, that maintaining U.S. economic growth likely will require several more rate cuts in coming months, with the next one possible at a Fed policymaking session on Nov. 19.

"This was an attempt to calm the waters and reassure people that the Fed stands ready to supply liquidity {cash} and backstop the financial system," said Bill Dudley, chief economist at Goldman Sachs & Co. in New York. "The Fed's concerned that if financial markets continue to deteriorate, it will hurt the real economy."

The move sparked strong rallies in the stock and bond markets. The Dow Jones industrial average, already up more than 100 points when the rate cut was announced shortly after 3 p.m., skyrocketed and closed at 8299.36, up 330.58 points, or 4.15 percent.

Meanwhile, yields dropped by a quarter of a percentage point on U.S. Treasury securities with maturities ranging from six months to five years. Yields on 30-year bonds fell to 4.97 percent, from 5.03 percent at the previous day's close, as their price, which rises when the yield goes down, climbed only $1.87 1/2 per $1,000 face value.

The dollar fell against the German mark and the Japanese yen.

In response to Greenspan's action, many major banks cut their prime lending rates to 8 percent from 8.25 percent, effective today. That will benefit those who have loans or credit cards with rates tied to the prime. The rates charged on many small-business loans are also linked to the prime. Mortgage rates, which rose last week, may drop again.

It is very unusual for the Fed chairman to act on his own authority to change rates instead of waiting for one of the central bank's regularly scheduled policymaking sessions. Greenspan's unilateral action yesterday was his first since April 1994, and only the second since he became chairman in 1987. But he discussed his intentions with other central bank officials around the country in a conference call, a Fed spokesman said.

The reduction in the Fed's target for the federal funds rate, the rate financial institutions charge one another on overnight loans, to 5 percent from 5.25 percent came less than three weeks after the rate had been trimmed from 5.5 percent. Wall Street's disappointment with the small size of the last cut prompted rumors that Greenspan might act on his own, but many analysts and investors assumed the cut wouldn't come until the Nov. 19 meeting.

In a statement announcing the action, the Fed said: "Growing caution by lenders and unsettled conditions in financial markets more generally are likely to be restraining aggregate demand in the future. . . . Further easing of the stance of monetary policy was judged to be warranted to sustain economic growth in the context of contained inflation."

Underscoring its concern about the state of the markets, the Fed also announced a cut in the discount rate to 4.75 percent from 5 percent. This rate, which normally is kept slightly lower than the federal funds rate, is the one financial institutions pay when they borrow money directly from their district Federal Reserve bank.

The Fed, which has the final say on the discount rate, approved the cut unanimously but without the participation of Fed Governor Edward M. Gramlich, who was out of town, the spokesman said. The boards of directors of eight of the 12 district Fed banks had requested such a reduction.

The most recent financial market upheaval was triggered in mid-August, when the Russian government defaulted on a portion of its debt. To a degree that has stunned Fed officials, as well as analysts and many investors, that default somehow reminded everyone that risky investments can turn sour. Since then, many investors and lenders have been dumping not just foreign holdings, ranging from Brazilian bonds to Hungarian stocks, but also many other securities and investments in the United States that carry above-average risk.

Much of the money raised through such sales has flowed into U.S. Treasury securities, which are considered a safe haven. Their yields, even before yesterday's declines, had been pushed down to levels not seen since the 1960s.

Meanwhile, the market for new stock issues and most new corporate bonds almost completely dried up. Firms with lower credit ratings were being forced to borrow from their banks, where they have been getting less money and paying more for it.

Dudley of Goldman Sachs noted that the same problem has emerged in the market for commercial paper, which are unsecured promissory notes issued by corporations. Firms unable to find buyers for their paper are being forced to obtain bank loans to pay off paper issued earlier.

"Basically, the Fed move was driven by concern about liquidity {in these markets}, not the real economy," Dudley said. "If you are worried about the real economy, you could wait a few weeks.

"This is a way of telling everyone, the lifeguard is back on duty. You can go back in the pool."

The rate reduction, and the resulting drop in the dollar, could help some hard-pressed developing nations such as South Korea, Thailand and Brazil, at least slightly, by discouraging investors from selling their currencies to buy dollars.

U.S. officials, such as Treasury Secretary Robert E. Rubin, are concerned that the recent flight of capital from Brazil could eventually force that country to default on its foreign debt. That could plunge Brazil's economy into a deep recession, drag down the economies of other Latin American nations and hurt the U.S. economy by reducing demand for American exports.

Nicholas Perna, chief economist for Fleet Financial Group in Boston, said that by affecting both U.S. and world markets, the Fed action "is keeping the odds of recession from rising."

"It's preemptive, in a sense, because the major U.S. economic indicators wouldn't warrant action at this point," he said.

The most likely outcome for the economy next year is what Perna called "a bumpy soft landing, in which the economy grows slowly, but it grows."

"If all we are working with is a bumpy soft landing, then we have at least a half-percentage point in rate cuts to go. If we really are facing a recession, then the Fed will cut" rates by two full percentage points, Perna predicted.