WASHINGTON — The Federal Reserve lowered its benchmark lending rate by one-quarter point Tuesday, which helped consumers but sent stocks plunging because Wall Street had been hoping for more.
The Fed's quarter-point cut in the federal funds rate — which banks charge each other for overnight loans — brought it down to 4.25 percent. Commercial banks quickly matched the move by lowering their prime rate, which they charge their best customers, down a quarter-point to 7.25 percent.
The Fed's third consecutive rate cut in recent months was welcome, but many on Wall Street were disappointed that the Fed didn't sharply lower the rate it charges banks at the discount window. This is a rate that the central bank charges private banks for short-term loans. The Fed cut the discount rate by a quarter-point, to 4.75 percent, but many on Wall Street had clamored for a deeper cut of a half-point or more to spur sluggish bank activity.
After the Fed's rate cuts, stocks fell sharply. The Dow Jones Industrial Average closed down 294.26 points at 13,432.77, the S&P 500 was down 38.21 points to close at 1477.65, and Nasdaq fell 66.60 points to 2652.35. Each index was down more than 2 percent.
The Fed's decision wasn't unanimous. The president of the Boston Federal Reserve Bank, Eric Rosengren, voted against the decision, arguing for a deeper cut.
In a statement, the Fed governors acknowledged that the risks of slowing growth and rising inflation are no longer in balance and that turmoil in credit markets is creating great uncertainty.
"Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks," the Fed statement said. "Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time."
The reference to moderate growth reflects the Fed's view that the economy may be in somewhat better shape than headlines suggest, said David Wyss, chief economist for the rating agency Standard & Poor's in New York.
"Ninety-four thousand new jobs (in November), 4.7 percent unemployment, manufacturing numbers that are soft but not terrible, early (Christmas) retail sales up — except for housing, which is obviously a mess, the rest of the economy doesn't look all that bad yet," he said.
Keith Hembre agreed that the Fed appears more optimistic than the markets. The chief economist for First American Funds, a Minneapolis-based mutual fund, had hoped for deeper rate cuts.
"They weren't aggressive. They failed to meet either the expectation or hopes that had been built into the market," said Hembre, acknowledging that the Fed "has a more favorable economic outlook than is generally embedded in the market."
Not everyone was disappointed. William Dunkelberg, the chief economist for the National Federation of Independent Business, said in a survey of small businesses that was published Monday that credit problems aren't being felt on Main Street and that rate cuts aren't needed.
"What does seem clear is that cutting rates will not get more houses built. Cheaper financing won't get builders to build houses that there is no demand for, and consumers already have plenty of houses available to buy," he wrote.
At the heart of today's economic problems is a severe housing slump, and the packaging of shaky mortgages into bonds of dubious value. Banks holding those suspect notes fear that they'll have to write down their asset values, and rather than take on more risks with new loans, some are hoarding their cash reserves. That's spawned mounting concerns that credit markets, where banks make short-term loans to corporations for funding day-to-day operations, may cease functioning as they should.
That's why some economists want the Fed to slash the discount rate more aggressively. The rate at the Fed's discount window is more expensive than in private markets in order to bring the federal government a premium when banks borrow from the lender of last resort. But if the Fed were to lower that discount rate, perhaps even below the fed funds rate, it would remove the stigma of borrowing from the government, spur borrowing and enliven credit markets.
If the discount rate became a bargain rate, "people will understand better why you are doing that" — borrowing from the Fed's discount window, said Jim Glassman, the senior U.S. economist for JP Morgan Chase & Co.
Speaking to reporters Monday at the headquarters of the Securities Industry and Financial Markets Association, Glassman said that banks fear that by borrowing at a premium, they may send investors a message that things are worse than they seem.
ON THE WEB
Read the Fed statement.