Fed drops benchmark rate to near zero

WASHINGTON – The Federal Reserve, urgently rewriting its playbook to fight a deepening recession, cut its benchmark interest rate to as low as zero Tuesday, a surprisingly strong step that should make it cheaper for Americans to borrow on credit cards and pay their mortgages.

Wells Fargo, Wachovia and U.S. Bancorp immediately lowered their prime lending rates from 4 percent to 3.25 percent, and other banks will probably follow suit. Economists cautioned, though, that people frightened by the economy and worried about their own jobs may not feel like taking on more debt.

The Fed’s action was unprecedented in the central bank’s 95-year history, and Wall Street embraced it. The Dow Jones industrials, which had been up about 120 points ahead of the Fed announcement, finished the day up nearly 360, a gain of more than 4 percent.

For the first time, the Fed created a target range for its funds rate, putting it at zero to 0.25 percent. That was a dramatic reduction from the previous rate, which was an already low 1 percent. The federal funds rate is the interest that banks charge each other for overnight loans.

The radical action underscores the breathtaking deterioration in the U.S. economy and the stability of the financial system this fall, and even since Fed policymakers last gathered in late October.

For years, cutting the funds rate had been the Fed’s most potent weapon for snapping an economy out of trouble. But the recession, which economists say began a year ago, seems to be worsening despite all the steps taken so far.

The move “will go down in the annals of Fed history,” declared Stephen Stanley, chief economist at RBS Greenwich Capital. “I nominate this one to be called the ‘Who Could Ask for Anything More?’ statement. The Fed is throwing everything in its arsenal.”

There was fresh evidence of the economic danger Tuesday before the Fed announcement. Housing starts for November plunged by almost 19 percent, the most in a quarter-century.

And consumer prices fell by a record 1.7 percent in November, the second straight monthly decline, raising fears the nation is in a dangerous bout of deflation – a widespread, prolonged decline in prices that would take a bite out of personal income and corporate profits and do further damage to the already pummeled housing market. The Fed’s lower rates could help prevent deflation from taking hold.

The bold move on rates surprised not just Wall Street investors but also economists, most of whom were predicting the Fed would cut its funds rate in half, to 0.5 percent.

With the Fed’s key rate sinking to near zero, the central bank moved into uncharted territory. Still, Fed Chairman Ben Bernanke and his colleagues insisted the central bank isn’t running out of ammunition to fight the crisis.

“The Fed will employ all available tools to promote the resumption of sustainable economic growth,” the Fed said.