Bernanke Fails to Calm Investors Asking for Rate Cuts

By Craig Torres

Oct. 8 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke's message of readiness to cut interest rates failed to assuage investors clamoring for immediate action to support jobs and growth.

Bernanke said in a speech yesterday that an intensifying credit crunch means officials must ``consider'' lowering borrowing costs. Three hours later, U.S. stock indexes closed at their lowest levels in five years and headed for their worst annual declines since 1937.

Fed officials, who have kept their benchmark rate at 2 percent since April, may have wanted time for their record loans to the financial industry and new programs, including purchases of commercial paper, to bear fruit before lowering rates. Investors instead perceive the economic outlook deteriorating more rapidly, necessitating rate reductions.

Bernanke and his colleagues ``understand the disease, but they haven't been able to pre-empt it,'' said Dominic Konstam, head of interest-rate strategy at Credit Suisse Group in New York. ``They haven't been able to move quickly to head the next thing off.''

The Standard & Poor's 500 Stock Index slid 5.7 percent yesterday to 996.23, after a 3.9 percent slump the previous day. The declines both followed pre-market opening announcements of fresh actions by the Fed to unblock credit markets. Stocks tumbled in Europe and Asia today and S&P 500 futures dropped 3.4 percent to 972 points.

On Oct. 6, the central bank doubled its planned auctions of cash to banks to as much as $900 billion. Yesterday, it unveiled a unit to buy commercial paper, debt used by companies for short-term funding.

`Best Choice'

``The Federal Reserve's massive injection of financial liquidity of late isn't registering with investors who appear to be clamoring for interest-rate cuts instead,'' said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. A reduction of at least three quarters of a point would be ``the best choice'' because it would help banks boost their margins between the cost of funds and rates of return.

Policy makers aren't scheduled to meet to consider changes to their benchmark lending rate until Oct. 28-29. The Federal Open Market Committee has left its target rate unchanged at the last three meetings after cutting it by 3.25 percentage points from September to April.

Traders see 32 percent odds of a three-quarter point move at or before this month's meeting, with 100 percent chance of a half-point move.

Waning Authority

In more typical market conditions, stocks rally when a Fed chief indicates he'll reduce rates. Now, Bernanke's message may have less power because traders already anticipated for weeks that policy makers would need to make that move, and because of rising concern even rate cuts may do little to immediately help banks scrambling to reduce their vulnerability to loan losses.

``In normal times, a rate cut would have a positive effect,'' said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco. ``What's troubling the market'' is concern about ``the solvency and losses of major institutions. The market is uneasy because it doesn't have a lot of information on what the depth of those losses will be.''

Bernanke has pushed the limits of the Fed's powers to create an array of unprecedented lending programs as the credit crisis spread from banks to securities firms, mutual funds, the biggest U.S. insurer and now corporate America.

Commercial Paper

The Fed yesterday said it will shore up the commercial paper market, a $1.6 trillion industry where banks get short- term funds and companies issue a type of IOU to pay for day-to- day activities such as payrolls and rent. That's on top of the auctions of cash to banks and some $147 billion in loans to Wall Street bond dealers and $152 billion in lending to backstop money market mutual funds as of Oct. 1.

While the liquidity facilities give the Fed a larger role in short-term financing, they don't replicate the lending by banks to businesses and consumers needed to give growth a lift.

``This is really a question of getting cash into the hands of middle-American businesses,'' said David Rosen, chief investment officer of the Graham & Dodd Fund LP in New York. ``The guy that needs credit is the average Joe who runs a business which employs 20 to 30 people.''

Financial conditions have worsened since Fed officials last cut interest rates in April. Commercial paper outstanding slid to a three-year low last week and consumer credit fell by $7.9 billion in August, the most since statistics began in 1943, Fed data showed yesterday.

Mortgage Loans

``Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit,'' Bernanke said.

Since the Fed chief's previous public address, on Sept. 24 to Congress, the three-month London interbank offered rate climbed 0.84 percentage point to 4.32 percent, indicating banks' growing concerns about each others' credit risks.

``Lack of trust and fears of more bankruptcies has made lenders and borrowers pull back from dealing with one another altogether,'' Christopher Rupkey, chief financial economist for Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, wrote in a note. ``Sometimes it feels as if we are going to be banking with the post office soon.''

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.