Tuesday, January 22, 2008

Growing Sense Of Panic In World Markets


Fed Cuts Key Interest Rate as Asian Markets Drop for Second DaySell-Offs on All Major Exchanges
By Neil Irwin, Howard Schneider and Ariana Eunjung ChaWashington Post Staff WritersTuesday, January 22, 2008; 12:03 PM
The Federal Reserve today slashed the short-term interest rate it controls by three-quarters of a percentage point, a surprise move meant to keep plummeting stock markets around the world from threatening the underpinnings of the international economy.
A day after stock markets in all major world economies plunged, the U.S. market followed, but suffered much less damage than markets in other large countries. After initially falling nearly 450 points this morning, the Dow Jones industrial average was down 157 points at 10:45 a.m., or about 1.3 percent. In comparison, over the course of yesterday and today, the Japanese stock market fell 9.3 percent. Analysts attributed the relatively minimal decline in the U.S. markets to the Fed's rate cut.
The Fed cut the federal funds rate, the rate at which banks lend to each other, to 3.5 percent, from 4.25 percent. The last time it cut rates that much was 1984. In its last surprise rate cut, following the Sept 11, 2001, terrorist attacks, it cut the rate by half a point. The decision was reached by the Federal Open Market Committee in an emergency videoconference last night that followed a cascading plunge of stock markets around the world. U.S. markets were closed yesterday for the Martin Luther King Jr. holiday.
"The economy is still staring recession in the face, but at least the Fed now gets it," said Ian Shepherdson, chief U.S. economist with High Frequency Economics.
The rate cut will ultimately lower what it costs consumers to borrow money for credit cards and auto loans and make it cheaper for businesses to take out loans to expand. And it could make it cheaper for banks to raise money, which would make them better able to weather the losses they are taking on home mortgage loans and other exotic investments.
"The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth," the policymaking committee said in a statement. "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."
The rate cut came a week before the policymakers were scheduled to meet. Fed Chairman Ben S. Bernanke generally has been reluctant to cut rates between regularly scheduled meetings, a tactic that his predecessor, Alan Greenspan, used more regularly.
One member of the Fed's policymaking committee, St. Louis Fed President William Poole, dissented on the vote. He preferred to wait until the regularly scheduled meeting Jan. 29-30. Another, Frederic S. Mishkin, did not participate because he was traveling.
"There is a growing sense of panic among central bankers about the course of the economy and both the widening and deepening of the credit crisis," said David Shulman, senior economist with the UCLA Anderson Forecast. Speaking about 15 minutes after U.S. markets opened, he said: "If the Fed hadn't acted, it would be a lot uglier. But the day is still very young and we're going to have quite a bit of volatility."
The further signs of a weakening economy made it more likely that Congress will pass -- and the president will sign -- an economic stimulus package. The White House said today that President Bush wouldn't rule out a stimulus package larger than the $150 billion he has already supported, according to an Associated Press report.
Treasury Secretary Henry M. Paulson Jr. urged Congress to move quickly on a stimulus package this morning in a speech to the U.S. Chamber of Commerce.
"I and my team have been actively engaged with policymakers here and around the world as we closely monitor the global equity correction," said Paulson. He said later that "our central bank is nimble and able to respond quickly to market conditions. . . . That should be a confidence builder."
Illustrating the reason for worry about the banking system, Bank of America said this morning that its fourth-quarter profit fell 95 percent, to $268 million, compared with the same period a year ago. The decline in earnings came because of a $5.3 billion write-down of assets tied to risky, subprime home mortgages. Wachovia Corp.'s fourth quarter profit was down 98 percent, to $51 million, for the same reason.
Today's declines in Asia were even more severe than those yesterday, and several markets hit multiyear lows. Indian shares plunged so quickly -- nearly 11 percent -- that its stock markets halted trading soon after opening. In South Korea, volatile futures prices prompted the main Kospi market to briefly suspend program selling orders at midday. The Australian market suffered its worst one-day fall ever, while Japan's Nikkei fell 5.65 percent to its lowest point since 2005. It is down nearly 18 percent this year.
In Hong Kong, the Hang Seng index was down 8.65 percent today, after dropping 5.49 percent yesterday. It's off 19 percent this year and is 30 percent lower than a peak in late October.
"This is an expression of panic -- really nothing less than panic about prospects for the U.S. economy," said Stephen Green, senior economist with Standard Chartered Bank.
For months, some economists had argued that Asian countries remained largely insulated from the problems in the United States because of strong growth in China and India. But recently, companies and financial institutions in those countries have announced that they, too, contain significant exposure to the subprime mortgage securities that have collapsed in the United States.
The markets fell as fears spread that massive losses on loans made to U.S. home buyers would cascade through the world financial system. Some of the firms that play important, but usually invisible, roles in the global financial architecture are turning out to be exposed to the downturn in the housing market in such a way that their ability to function is threatened.
The companies that insure bond investors against defaults are having to make massive payouts. One, ACA Financial, owes $60 billion that it cannot afford to pay and has been taken over by the Maryland insurance regulator. Its credit rating has been lowered.
The problems among bond insurers have meant that a wide variety of financial institutions cannot count on receiving payments due them, causing further losses.
Those losses could have importance beyond the hit they cause to the banks' share prices. Banks and other financial institutions play an important role in an economic downturn: lending to businesses and consumers so they can help the economy get back on track. The multibillion-dollar losses could make them unable to play that role.
Moreover, foreign investors have been plowing capital into U.S. banks to help them continue lending, which made the losses particularly worrisome, some analysts said.
"Those infusions of capital have been crucial to maintaining performance to date," said Joseph Mason, a finance professor at Drexel University in Philadelphia. "If foreign investors should significantly retreat from U.S. markets, that leaves us to our own recovery. In that case, the current credit crunch will continue to bite and we maintain a very high risk of recession."
Many economists have argued that continued growth in the rest of the world -- especially in fast-growing markets like China -- will help ease the pain of the slowdown in U.S. growth.
With their houses less valuable, U.S. consumers may start spending less, goes this logic, while Asian and European consumers will do just fine, preventing a global economic slump. Yesterday, analysts worried that this theory won't hold up.
"People are scared, and they are reacting with behaviors which are based on psychology," said David Kotok, investment chief of Cumberland Advisors. "Some of that can be seen in the stock market, but they are also changing consumer behaviors."
Many market analysts argued that stock markets in developing countries have appeared to be overvalued for some time, which would suggest that some of the market declines were necessary. For example, even after Monday's 5.1 percent drop, the Shanghai composite index in China has risen more than fivefold in the past three years, sparking worries of a bubble.
"Many of the markets, especially the European and Asian markets, have been priced for eternal growth," said Axel Merk of the Merk Hard Currency Fund.
European officials stressed the underlying strength of their economies, arguing that they can continue to thrive despite weakness in the American economy.
"It seems that the markets are considering the possibility of a more pronounced slowdown, even a recession in the U.S.," European Union Monetary Affairs Commissioner Joaqu¿n Almunia told reporters yesterday. "I hope they will pay attention also to the real information . . . because, at least in Europe, the economic fundamentals of our economies are sound."

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