Fed Slashes Rates To Near 0%, Makes Historic Policy Shift

Originally Published: Investor's Business Daily

BY SCOTT STODDARD

INVESTOR'S BUSINESS DAILY

Posted 12/16/2008

The Federal Reserve cut interest rates to as low as 0% on Tuesday and signaled it will use asset purchases as its primary tool to ease the credit crunch and jolt the economy out of recession.

Stocks, up modestly before the announcement, surged after the rate cut and historic policy shift. The Dow jumped 4.2%, the S&P 500 5.1% and the Nasdaq 5.4%.

Policymakers voted 10-0 to cut the fed funds target rate for overnight bank loans — from 1% to a record-low range of 0% to 0.25%. Analysts expected a half-point cut.

The Fed said in its post-meeting statement that the economy has deteriorated across the board, justifying "exceptionally low" rates for "some time."

With rates essentially at zero, the Fed will "employ all available tools" to jump-start the economy and restore normal credit. It specifically cited the use of its balance sheet, which has swelled above $2 trillion.

The central bank said it will buy "large quantities" of debt issued by government-backed mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE) over the next few quarters and buy mortgage-backed securities to bolster the housing market. Last month the Fed announced a $600 billion plan. It now says it's ready to expand those purchases if needed.

It will also consider buying "longer-term" Treasuries and take further steps to make credit more available to households and small businesses.

The 10-year Treasury yield dived, falling 25 basis points to a record-low 2.26%. That's expected to push mortgage rates down further, spurring home sales and helping troubled homeowners refinance into more affordable loans.

But November housing starts plunged 18.9% to an annual pace of 625,000 units, the lowest since records began in 1959, the Commerce Department said. It was the worst monthly drop in 24 years.

Permits fell 15.6% to 616,000, the lowest on record, a bad sign for future building activity.

"This is mind-bogglingly awful," Ian Shepherdson, chief U.S. economist at High Frequency Economics, said in a note.

On the upside, fast-falling home construction will eventually reduce the glut of unsold homes.

November consumer prices dived 1.7%, the most since records began in 1947, as energy prices cooled 17%, the Labor Department said. Compared to a year ago, prices were up 1.1% vs. 5.6% in July.

Core prices, which exclude food and energy, were unchanged vs. October.

"Not only is growth collapsing but so is inflation," said Dana Johnson, chief economist at Comerica Bank.

But aggressive Fed action and a likely 2009 government stimulus package as high as $700 billion will eventually pull the economy out of its tailspin, Johnson predicted.

"There is so much stimulus being applied that when the economy does turn around, it's going to do so fairly impressively," he said.

Gross domestic product shrank at a 0.5% annual rate in the third quarter and economists predict a much bigger contraction in the fourth quarter. The National Bureau of Economic Research recently said the U.S. fell into recession in December 2007.

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