By Matthew Benjamin
Sept. 16 (Bloomberg) -- The Wall Street convulsions that took down two of the largest investment banks in 24 hours threaten to make it harder for consumers and companies to borrow, push unemployment higher and put pressure on the Federal Reserve to consider an interest-rate cut.
The Federal Open Market Committee meets in Washington today amid a crisis atmosphere triggered by the collapse of Lehman Brothers Holdings Inc. with $613 billion of debt. While policy makers haven't signaled a cut and few economists predict one today, futures traders put the odds of a reduction at 68 percent, up from 12 percent at the end of last week.
``The turn of events over the weekend is going to make things more difficult,'' said Dan North, chief economist of credit insurer Euler Hermes, a unit of Allianz SE, in Owings Mills, Maryland. ``The Fed has made a lot of credit available, but no one wants to use it because there's still fear that whoever you lend it to is going to go bankrupt.''
By pushing up the price of money, the meltdown may further depress consumer spending that was propped up last quarter by tax rebates. That would leave the economy, which some economists say is already in recession, increasingly dependent on exports as the jobless rate climbs and industrial production contracts.
``Until the financial sector sorts itself out the economy is never going to resume normal growth,'' said Ken Rogoff, former chief economist at the International Monetary Fund and now a Harvard University professor.
Traders Anticipate Reversal
The FOMC will keep its benchmark rate at 2 percent for a third straight meeting, according to 100 of 105 economists in a Bloomberg News survey. Traders, by contrast, are increasingly convinced that the Fed will lower rates, a reversal from last month, when officials ``generally'' agreed the next move would be an increase, minutes of the gathering showed.
Policy makers cut rates seven times from September 2007, a month after the credit crisis began, through April. They suspended the easing as oil prices surged, increasing expectations inflation would accelerate. The FOMC is scheduled to announce its decision at about 2:15 p.m. in Washington.
``It is more likely they will move in October if things don't improve,'' said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. ``Mortgages and bank loans are going to be more difficult to get. The ability of anybody to make a loan and securitize it is going to be more difficult. It is going to be a challenge.''
Hoarding Cash
Yesterday, the federal funds rate soared as high as 6 percent, triple the Fed's target, as banks hoarded cash. That spurred the Fed to pump $70 billion into money markets through repurchase operations, the most since September 2001.
Premiums on investment-grade U.S. corporate bonds climbed. The extra yield investors demand to buy such bonds instead of Treasuries with a comparable maturity soared to 3.80 percentage points, the highest since Merrill Lynch began keeping the data in 1996, from 3.44 percentage points on Sept. 12.
``Certainly there will be an increase in credit costs, manifested in rising credit spreads, that will contribute to the slowdown,'' said Mark Gertler, a New York University economist and research co-author with Bernanke.
Should Chairman Ben S. Bernanke and his colleagues on the FOMC forego a rate decrease today, they may note in their statement that risks to financial stability have increased, while those of inflation have waned. That may offer a signal that officials are prepared to cut if needed to help the economy.
`Surprised' at Markets
``I am surprised that the market has been pricing in such a high possibility of a rate cut,'' said former St. Louis Fed President William Poole in an interview with Bloomberg Television. ``If the Fed responds by cutting rates, it would be suggesting to the market that it believes turmoil is likely to continue and there must be much deeper repercussions.''
Credit was tightening before the events over the weekend. The Fed last month said more banks stiffened loan terms for consumers and businesses since April as delinquencies climbed.
Most ``domestic institutions reported having tightened their lending standards and terms on all major loan categories over the previous three months,'' the Fed said in its quarterly Senior Loan Officer Survey.
How much of an impact the crisis has may depend on banks' ability to keep credit flowing.
Banks Drop
National City Corp., Fifth Third Bancorp and Sovereign Bancorp Inc. fell in New York trading yesterday on concern that regional banks already facing losses tied to subprime mortgages are vulnerable to losses from Lehman or will pay more to borrow because of its failure.
The U.S.'s slide may also have an impact on other nations starting to falter. Japan and the 15-nation euro area contracted in the second quarter, while the European Commission says Spain and the U.K. are already in recession.
``It shortens the odds for a deeper global economic downturn,'' said Thomas Mayer, chief European economist at Deutsche Bank AG in London. ``The storm has emanated from the U.S. but'' it will ``weigh on the world economy everywhere.''
To contact the reporters on this story: Matthew Benjamin at mbenjamin2@bloomberg.net
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