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Fed Holds Rates Steady Amid Shake-Up, Officials Opt to Stay Course

September 17, 2008

By JEANNINE AVERSA

By Jeannine Aversa

The Associated Press

WASHINGTON

Federal Reserve Chairman Ben Bernanke and his colleagues decided to keep a key interest rate steady Tuesday. They acknowledged that stresses in financial markets have grown, though, and hinted that they stood ready to lower rates if needed.

But the Fed’s tough-love stance on interest rates was overshadowed by a government plan announced late Tuesday to take over American International Group Inc. and rescue the insurance giant from the brink of bankruptcy.

Wreckage on Wall Street in recent days did not force the Fed – as some thought possible – to reverse course and cut rates. The Fed left its key rate at 2 percent for the third straight meeting. It marked the first meeting this year that the Federal Open Market Committee, which sets interest-rate policy, agreed unanimously on a decision.

The prime lending rate for millions of consumers and businesses stayed at 5 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans. The Fed’s key rate and the prime rate are at four-year lows.

The Fed’s view of economic and financial conditions, however, was more dour than its last assessment in early August. Economic growth appears to be slowing as consumers hunker down and export growth cools off a bit, Fed policymakers said. And “strains in financial markets have increased significantly,” the Fed said.

The more bearish tone indicates the Fed is again open to rate cuts down the road, some analysts said .

“The Fed has opened the door to a rate cut that many thought was closed,” said Stuart Hoffman, chief economist at PNC Financial Services Group. “I think there was more emphasis about the economy being weak.”

The Fed said it would “act as needed.”

In recent days, the American financial system has suffered a shake-up as bad bets on mortgage-backed securities claimed more Wall Street giants.

Lehman Brothers, the country’s fourth-largest investment bank, filed for bankruptcy protection. A weakened Merrill Lynch, deciding it couldn’t go it alone anymore, found help in the arms of Bank of America. And with AIG wobbling, the government said late Tuesday that it would put up $85 billion to help rescue the insurer.

Earlier Tuesday, the Dow Jones industrials gained 141 points after the Fed’s action soothed market anxiety . The Dow had plunged 500 points Monday, the most since September 2001 .

So far this year, 11 federally insured banks and thrifts have failed, compared with three last year.

Urgently trying to keep cash flowing amid a Wall Street meltdown, the Fed pumped another $70 billion into the nation’s financial system to help ease credit stresses. In emergency sessions over the weekend, the Fed expanded its loan programs to Wall Street firms, part of an ongoing effort to get credit flowing more freely.

By standing pat now, the Fed is leaving room in its rate-cutting arsenal to act later if needed.

“The Fed has kept its powder dry,” said Terry Connelly, dean of Golden Gate University’s Ageno School of Business.

Over the past few months, Bernanke and his Fed colleagues have signaled that the central bank’s next move on interest rates would probably be an increase to fend off inflation. Now, economists are saying, the likelihood of a rate increase over the next six to nine months has all but disappeared.

Inflation should moderate later this year and next year, the Fed said. It dropped language contained in its August assessment that some barometers of consumer and business expectations of inflation have been “elevated.” That suggested slightly less concern about inflation even as the Fed made clear it would remain vigilant on that front.

Fed leaves rates unchanged for now

With Wall Street on edge, some analysts expected a rate cut, but the Fed left its key rate at 2 percent for the third straight meeting. Now, economists say, it’s unlikely the Fed will raise rates over the next six to nine months.

Late Tuesday, the Fed agreed to an $85 billion bailout of insurance giant AIG. Story, Front section

Originally published by BY JEANNINE AVERSA.

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