Fed cuts rates by a quarter point

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NEW YORK (CNNMoney.com) -- The Federal Reserve lowered an important short-term rate by a quarter of a percentage point Tuesday, the latest in a series of rate cuts that the central bank hopes will stimulate an economy some fear is on the brink of a recession.

But stocks plunged following the Fed's announcement as Wall Street was disappointed the Fed did not act more aggressively. The Dow dropped nearly 300 points, or 2.1 percent, while the S&P and Nasdaq each fell about 2.5 percent.

"The Fed needed to cut more now in order to fend off the credit crisis that has intensified in the past month," said John Derrick, director of research at U.S. Global Investors, a money management firm in San Antonio with more than $5.5 billion in assets.

This was the third straight time that Fed Chairman Ben Bernanke and fellow policy makers decided to cut its federal funds rate, an overnight bank lending rate that affects how much interest consumers pay on credit cards, home equity lines of credit and auto loans.

The federal funds rate now stands at 4.25 percent. The central bank also cut its discount rate, which is what banks pay to borrow directly from the Fed, by a quarter-point to 4.75 percent on Tuesday.

One member of the Fed's policy making committee, Federal Reserve Bank of Boston President Eric Rosengren, voted for a half-point cut in the fed funds rate.

In fact, some investors had been holding out hope that the Fed would lower rates by a half of a percentage point as it did in September since several banks have been forced in the past few months to take massive writedowns due to exposure to bad mortgage loans.

"The market is dropping hard. I think that investors probably priced in a little more than a quarter-point cut," said Randy Carver, president of Carver Financial Services, a Mentor, Ohio-based investment firm with $680 million in assets under management.

Leading up to Tuesday's meeting, several economists indicated that the Fed may need to lower rates several more times in early 2008 in order to keep the economy from slipping into a prolonged slump.

But the Fed's statement reflected a less dire view of the economy than what many on Wall Street believe - a possible sign that the central bank might not cut rates at its next meeting in January.

The Fed acknowledged that "economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending." It also said that "strains in financial markets have increased in recent weeks."

The Fed added that "some inflation risks remain" and the Fed "will continue to monitor inflation developments carefully."

That tone disappointed investors, who had been hoping the Fed would take more decisive action to clean up the mortgage mess that's plaguing Wall Street and is starting to take its toll on Main Street.

"This was a big mistake. They should have at least cut the discount rate by 50 points. I think that was a big disappointment to Wall Street," said William Rutherford, president of Rutherford Investment Management, a money manager based in Portland, Ore. "The Fed must contain the housing problem. If it doesn't, we are definitely heading into a recession."

Another investment strategist suggested that the Fed, despite what it said Tuesday, will continue to lower rates in January and perhaps several more times in 2008.

"The good news is that the Fed is going to be more flexible. Even though the market is selling off, there has to be more to come. This is not the last rate cut," said Hank Smith, chief investment officer of Haverford Investments, a Radnor, Pa.-based money manager with $6.5 billion in assets under management.

Concerns that the impact of the subprime mortgage crisis is spreading sparked President George W. Bush and Treasury Secretary Henry Paulson to unveil a plan last week that would freeze interest rates for some subprime borrowers whose adjustable-rate mortgages are scheduled to reset in 2008.

But one market expert said investors were wrong to think that the Fed would keep cutting rates drastically just to save banks and troubled borrowers.

"The Fed is not going to bail out the market. Time will heal these wounds. People don't want to hear that but it's the real world," said Rich Berg, chief executive officer of Performance Trust Capital Partners, a Chicago-based bond trading firm.

Carver said one reason the Fed may have decided to not cut rates by a half-point is because it is still waiting to see how consumer spending holds up during the holidays. He argues that the Fed won't want to cut rates too drastically if the economy doesn't really need it.

To that end, Carver pointed out that the labor report for November, released last Friday, showed no major ill effects of the mortgage crisis since employers added more jobs than expected and the unemployment rate held steady.

"The Fed is looking two to three months out and doesn't want to cut too much if there is some decent strength in the economy," Carver said.."The Fed doesn't want to overstimulate the economy since that could cause bigger problems down the road."