Federal Reserve policy makers don't expect to know for days whether their Aug. 17 discount-rate reduction will succeed at calming markets, Fed watchers say.
Yields on three-month Treasury bills yesterday fell the most since the 1987 stock-market crash as money market funds dumped asset-backed commercial paper in favor of the shortest-maturity government debt. Fed officials, who said they would accept everything from home-equity finance to municipal bonds as collateral for loans, expect some disruptions because banks are more cautious about what collateral they themselves accept.
"What the Fed wants to do is buy time to sort these things out," said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.
Fed Chairman Ben S. Bernanke is trying to avoid an emergency cut to the benchmark lending rate between banks, focusing instead on trying to maintain liquidity in markets. Futures traders are betting he'll fail and that the credit crunch will force him to ease monetary policy for the first time since 2003.
"The Fed doesn't want to bail anybody out," said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. "If they can get through the next couple of weeks, maybe cooler heads will prevail."
Bernanke and New York Fed President Timothy Geithner are listening to the concerns of senior Wall Street executives and following markets closely. They are assisted by William Dudley, executive vice president at the New York Fed in charge of markets, and Brian Madigan, the Fed's director of the Division of Monetary Affairs. Dudley is a former Goldman Sachs Group Inc. economist.
Paulson attempted to soothe jittery investors on Tuesday, insisting the United States will safely get through a spreading credit crisis that has unhinged Wall Street.
"You're going to see liquidity return to normal," Treasury Secretary Henry Paulson said today in a CNBC interview in Washington. "What Americans need to understand is these things take time.
We are going to work through this problem just fine," Paulson said.
Paulson commented as the Federal Reserve, trying to further stabilize the reeling markets, pumped another $3.75 billion into the financial system Tuesday. It was the latest in a series of cash transfusions that have topped more than $100 billion since last week.
Politicians have started turning their attention to the Fed's role as the market upheaval continues. Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat running for his party's presidential nomination, met with Bernanke and Treasury Secretary Henry Paulson today to discuss responses to "ongoing turmoil" in the markets.
Senate Budget Committee Chairman Kent Conrad yesterday called for the resignation of St. Louis Fed Bank President William Poole. Conrad, a North Dakota Democrat, said in a statement it was "irresponsible" for Poole to say in an Aug. 15 interview that only a "calamity" would justify a rate cut. Poole declined to comment, according to his spokesman, Joseph Elstner.
"It is so hard to forecast what the Fed is going to do," said LaVorgna of Deutsche Bank, adding that there may still be room to reduce the discount rate again. "I just don't know if they have exhausted all possibilities yet."
Fed officials still don't seem to be convinced that a system-wide failure is at hand. Commercial banks are profitable and as of the second quarter more than 97 percent of all residential real-estate loans were current on payment, according to Fed data. The Federal Open Market Committee is trying address the liquidity needs through alternative tools such as the discount window.