Fed cuts key interest rate a quarter-point

updated 5:43 p.m. ET Dec. 11, 2007

The Federal Reserve gave borrowers a rate cut present for the holidays. Wall Street’s response: Bah humbug!

Fed Chairman Ben Bernanke and all but one of his colleagues agreed Tuesday to trim the central bank’s most important interest rate by one-quarter percentage point to 4.25 percent. That left the federal funds rate at a nearly two-year low. The action is aimed at preventing a housing and credit meltdown from pushing the economy into recession.

Wall Street, though, thought the Fed was being stingy and stocks took a nosedive. Some investors were hoping for a bigger, half-percentage-point cut. The Dow Jones industrials plunged 294.26 points to close at 13,432.77.

“This seems to have disappointed some on Wall Street who were looking for a little more in their Christmas stockings this year from Santa Bernanke,” said Scott Anderson, economist at Wells Fargo Economics.

The rate reduction, the third this year, was needed to energize national economic growth, Fed officials explained. The deepening housing slump is affecting the behavior of consumers and businesses alike, they said.

“Economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks,” the Fed said in a statement. The three rate cuts ordered thus far “should help promote moderate growth over time.”

The Fed left the door open to additional rate cuts; many economists predicted the Fed will be forced to continue lowering the funds rate in the coming months.

The funds rate affects many other interest rates charged to individuals and businesses and is the Fed’s most potent tool for influencing economic activity.

In response, commercial banks, including Wachovia and Wells Fargo, lowered their prime lending rate by a corresponding amount, to 7.25 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans.

The fact that the Fed’s key rate was lowered again marked an about-face for the central bank. At its previous meeting in October, Fed officials hinted that their two rate cuts probably would be sufficient to help the economy survive the housing and credit stresses. Since then, however, financial conditions have deteriorated, prompting Bernanke to signal before Tuesday’s meeting that another rate cut may be needed after all as an insurance policy against undue economic weakness.

As another bolstering move, the Fed on Tuesday also lowered its lending rates to banks by one-quarter percentage point to 4.75 percent. That was the fourth cut to the discount rate since mid-August.

“Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,” the Fed said in its statement.

Banks, financial companies and other investors who made loans to people with spotty credit or put money into securities backed by those subprime mortgages have lost billions of dollars. Investors in the U.S. and abroad have grown more wary of buying new debt, thereby aggravating the credit crunch.

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