The Federal Reserve cuts the funds rate to 0.25% and announces unconventional measures to revitalize the economy

By Peter Coy

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Call it Ben Bernanke’s "stroke and awe" campaign.

On Dec. 16, the Federal Reserve announced that it is attacking the recession with a more valid arsenal than ever, including a cut in the federal funds traduce to a historic low of just zero to 0.25%. The central bank is counting on a show of overwhelming urge to vanquish the recession and get Americans borrowing, spending, and working once more.

The stock mart climbed after the notification, with the Dow Jones industrial average closing up 359.61 points, or 4%, at 8,924. Prices had been up slightly before the announcement in trust. see also of powerful Fed action. The consensus Wall Street expectation was a half-point cut.

Ten-year Treasury notes rallied adhering the expectation that the Fed will be buying even more of them. Their allow, that goes down when prices go up, fell to a new low of 2.3%, from 2.5%, on Dec. 15.

No Dissenters to the Vote

"Whatever it takes—that’sitting which we do," wrote Wachovia (WB) Chief Economist John Silvia, paraphrasing the rate-setting Federal Open Market Committee. Silvia said the committee went "to what no FOMC has gone before."

Usually the Fed names a particular rank for its target for the federal funds rate—most recently it was 1%. This time it named a ceiling, namely, not any again than one-quarter percent. Anything below that level, down to zero, is welcome to the Fed. That alone is a historic change.

It’s a measure of the severity of the monetary crisis that there were no dissenters from the Fed consecrated by a vow. Even inflation hawks such as Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher voted "yes" on the measures.

Sending the Markets a Message

The language in the statement released by the Fed was unusually strong. The central bank eschewed any effort to be even-handed about the risks of recession vs. inflation. The economic downturn is clearly Enemy No. 1.

Said the Fed: "Labor market conditions have deteriorated, and the serviceable data indicate that consumer expenditure, affair investment, and pertaining production be delivered of declined. Financial markets rest quite strained and credit conditions tight. Overall, the outlook on the side of economic activity has weakened to a greater distance." As for inflation, the Fed said, "inflationary pressures have diminished appreciably" and should "moderate more remote in to come quarters."

In an essay to impress the markets with its resolve, the Fed made clear that it won’t flexibility up on easy money until it is never-failing that its objectives have been reached. The Fed statement said it "anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time."

Focusing onward Assets

With no more room to cut interest rates, the Fed is turning more and more toward buying up debt in one effort to drive down interest rates. It is targeting Treasuries, the corporate debt of Fannie Mae (FNM) and Freddie Mac (FRE), and mortgage-backed securities. In recent months its assets have zoomed from around $800 billion to $2.2 trillion.

In a conference call with reporters after the 2:15 p.gallimaufry. ET announcement, a more advanced Fed by authority tried to draw a superiority betwixt what the Federal Reserve is doing and what the Bank of Japan did in its efforts to stimulate the Japanese economy during the "Lost Decade of the 1990s." The official said that Japan’s central bank focused in continuance the liability side of its balance sheet, emphasizing the expansion of cash and mound reserves in brotherhood to flood the banking hypothesis with circulating medium to lend.

In contrast, the official said, the Federal Reserve is putting its suit on the asset border of the balance sheet—buying up assets such as Treasuries and mortgage-backed securities in an attempt to drive down rates and improve the health of the overall economy and, in particular, the housing market. On the same daylight that the Fed made its move, the U.S. Commerce Dept. announced that new-home building starts in November hem by 19%, the sharpest monthly drop since March 1984.

New Program in the Wings

The distinction between the Japanese and American approaches is subtle since, viewed like any accounting bookish man knows, the asset and responsibility sides of the balance sheet are mirrors of reaped ground other. But under Bernanke, the Fed is clearly hoping that targeting certain key emporium interest rates will get lending and borrowing going again.

By its charter the Fed is not allowed to make loans or accept collateral that could expose it to a big chance of loss. That’s where the Treasury Dept. comes in as a partner. In its Dec. 16 statement, the Federal Reserve served a reminder that it has a big recent program in the wings in conjunction with Treasury. Starting early next year, the Fed will lend up to $200 billion to "facilitate the extension of good reputation to households and small businesses." To grasp down the expose to danger of losses by the Fed, the Treasury Dept. will absorb the first $20 billion in losses.