Fed unveils plan to fund some business loans

updated 5:37 p.m. ET Oct. 7, 2008

WASHINGTON - The Federal Reserve moved swiftly to break through a credit clog that is imperiling the economy, saying Tuesday it would buy massive amounts of short-term debt and hinting that it may cut interest rates.

Wall Street — the main target of his attention — was unimpressed, falling deeper into depression despite the news. The Dow Jones industrials shed more than 500 points.

Fed Chairman Ben Bernanke warned that the financial crisis has not only darkened the country’s current economic performance but also could prolong the pain.

“The outlook for economic growth has worsened,” Bernanke said in a speech at the annual meeting here of the National Association for Business Economics.

His more gloomy assessment appeared to open the door wider to an interest rate cut on or before Oct. 28-29, the central bank’s next meeting, to brace the wobbly economy. The Fed’s key interest rate now stands at 2 percent.

President Bush, saying the economic meltdown has brought tough times for many Americans, pledged that “we’re going to come through this.”

“Have faith, this economy is going to recover over time,” Bush said in a speech at an office supply company in the Washington suburb of Chantilly, Va. “I wish I could snap my fingers and make what happened stop. But that’s not the way it works.”

The president earlier reached out to European leaders to urge coordination on efforts to solve the financial crisis spreading around the globe. The White House said Bush was open to the idea of a leaders’ summit on the economic upheaval.

Stocks slumped, however, as investors focused on Bernanke’s warnings and worries about the weakness of financial companies. Bank of America Corp. reported its third-quarter profits fell 68 percent. The three major U.S. stock indexes all fell more than 5 percent a day after a huge selloff Monday put the Dow below 10,000 for the first time in four years.

The statements came against a backdrop of increasing concern that a global recession is rapidly developing. There is growing pressure for the U.S. government to do more beyond the $700 billion financial bailout package President Bush signed into law Friday.

To that end, the Fed invoked Depression-era emergency powers to begin buying commercial paper — short-term funding that many companies rely on to pay their workers and buy supplies.

The government’s bailout package is aimed at thawing lending by buying rotten mortgages and other bad debts from banks and other financial institutions. By getting these bad debts off bank’s balance sheets, they might be in a better position to raise capital and more willing to lend to each other and to customers.

Tight credit has made it increasingly difficult and expensive for companies to raise money to fund their operations.

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“The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding,” Bernanke explained.

Commercial paper is a way of borrowing money for short periods, typically ranging from overnight to less than a week.

In more normal times, about $100 billion of these short-term IOUs were outstanding at any given time, sold by companies to buyers that included money market mutual funds, pension funds and other investors. But this market has virtually dried up as investors have become too jittery to buy paper for longer than overnight or a couple of days.

The unstable situation has left many companies vulnerable. The notion under the plan is for the government to provide a “backstop” that would give companies a new place to get cash, the Fed said. The action makes the Fed a crucial source of credit for nonfinancial businesses in addition to commercial banks and investment firms.

Credit markets eased slightly, however, after the Fed’s move raised hopes it would quickly relieve the short-term funding problems plaguing some companies.

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