The Fed Comes Out Blazing

Central banks open up their ATMs—but is anybody in line?

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The next Federal Reserve policy meeting isn't scheduled until the end of January, but there will be no winter break for the central bank or its chairman, Ben Bernanke. The continuing global credit crunch stemming from the tumbling U.S. housing market has pushed the Fed and other major central banks into their most activist role since the Asian currency crisis in 1997.

First up are two $20 billion loan auctions this week for cash-strapped banks at rates far below what the Fed charges for loans from its "discount window." (Two more auctions will be held in January.) They are one half of a two-pronged financial rescue effort announced by the Fed and other big central banks the day after the financial markets booed a skimpy quarter-percentage-point cut in the federal funds rate. In addition, the Fed set up lines of credit with foreign central banks to allow them to pump dollars into their banking systems. "In effect, the Fed will lend dollars to these central banks, which can then lend them to commercial banks in Europe," says Jay Bryson, global economist at Wachovia. "The actions have the potential to end the crunch that has paralyzed credit markets for the past few months.... I think the Fed is getting ahead of the curve."

If Bryson is right, global interest rates should fall—though they did not immediately and Wall Street was less than persuaded, as traders evaluated whether the dramatic moves were a sign of panic. Many domestic adjustable-rate mortgages are linked to the London Interbank Offered Rate, or LIBOR, which has remained stubbornly high even as the Fed has cut the fed funds rate by a full percentage point. And despite the actions of the Fed, the Bank of England, the European Central Bank, and others, risk-averse banks continue to stand pat in the wake of the collapse of mortgage-backed securities held by banks around the globe. The key three-month LIBOR is still just under 5 percent, vs. 4.25 for the fed funds rate. But it's still early. An analysis by Brown Brothers Harriman concludes that "over the long run, this is a positive for the global outlook as better coordination and more proactive measures will get the markets to be a bit less pessimistic about the subprime fallout."

Yet it's clear that many economists and investors think the Fed has more work to do in order to both thaw global credit markets and reduce the odds of a U.S. recession or at least to make any downturn less severe. Economist Jan Hatzius of Goldman Sachs, while calling the Fed money auctions a "useful tool," would also like to see Bernanke's Fed drop the fed funds rate to as low as 3 percent by mid-2008 and predicts it will. An emergency rate cut before the late-January meeting is possible, too. Just the sort of Christmas present, even if it's a late one, that investors would cheer.