Bernanke hangs tough by holding rates steady

John W. Schoen Senior producer • Profile • E-mail

Despite pressure from the financial markets to cut interest rates, Fed Chairman Ben Bernanke and the board’s policymakers sent a strong signal that they are hanging tough by leaving rates just where they are.

Even as oil prices continue to fall toward $90 a barrel, Bernanke & Co. warned that the inflation outlook remains “highly uncertain.”

Many had hoped the Fed would offer up another cut to calm the storm swirling through the global financial markets. The upheaval so far has caused the collapse of Lehman Bros., the shotgun sale of Merrill Lynch and increased worries about the possible failure of insurance giant AIG.

Several publications reported late Tuesday that the Fed was close to a deal to loan at least $85 billion to AIG in exchange for an 80 percent equity stake.

Though the Fed held steady on rates, the central bank is hardly sitting on its hands. As the markets churn through the damage inflicted by hundreds of billions of dollars in losses from bad loans, the Fed continues to lend money to banks and investment firms. And it has become a lot less choosy about the assets it takes back as collateral.

“Through the back door, with the (lending) facilities they have, they're making a lot of credit available," said John Silvia, chief economist at Wachovia. “They're easing that way, but not changing the federal funds rate."

As banks continue to reasses the value of their mortgage loans and related investments, they face continued losses. Cutting the federal funds rate, and lowering the cost of money, helps banks boost profits on new loans and make up for the losses on loans that go bad.

By holding rates steady, the Fed is setting a limit on how far it is willing to cut rates to help banks repair their battered balance sheets. Just as Treasury Secretary Hank Paulson cautioned Monday that ailing financial firms shouldn’t count on taxpayer-funded backstops, Bernanke signaled Tuesday they the Fed's primary mission is fighting inflation and promoting economic growth — not aiding ailing banks.

“I think what they're trying to say is that they do have a lot of tools in their tool box and that they’re using them aggressively," said Ken Volpert, a portfolio manager at The Vanguard Group.

Leading up to the meeting of the Fed, the price of money in the futures market indicated that investors expected a quarter-point rate cut to help struggling financial companies and give a boost to the stock market, which Monday suffered its worst day in more than six years. After the Fed’s decision was announced Tuesday, traders on the floor of the New York Stock Exchange booed loudly.

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