Fed may lower rates again

Washington — As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates — perhaps to their lowest point in more than four years with the hope of relieving some of the pain felt by many Americans.

The convergence of a housing collapse and a lockup in lending has created the worst financial crisis in more than a half-century. Alan Greenspan, who ran the Fed for 18 1/2 years, called it a “once-in-a century credit tsunami,” and conceded that he made mistakes that may have aggravated the economy’s slump.

With a recession seen as inevitable, if not already under way, any Fed rate cut would be aimed at cushioning the fallout.

Vanishing jobs and shrinking paychecks have forced consumers to cut back sharply. Millions of ordinary Americans have watched their 401(k)s and other nest eggs shrink and the value of their homes drop, making them feel in even worse financial shape. In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.

“These are sobering times,” said Paul Kasriel, chief economist at Northern Trust Co.

All the problems have been feeding on each other. So far, Fed Chairman Ben Bernanke and his colleagues haven’t been able to break the vicious cycle, despite hefty rate reductions and a flurry of unprecedented steps aimed at getting credit flowing more freely again.

Bernanke says he’ll use all tools to battle the crisis.

To that end, Fed policymakers are widely expected to lower the central bank’s key interest rate at the conclusion of a two-day meeting Wednesday — their last session before the November elections.

Investors and some economists predict the central bank will drop the rate by half a percentage point to 1 percent. If that happens, it would mark the lowest rate since the summer of 2004. Others, however, think the rate will be cut by a quarter-point to 1.25 percent.

In turn, rates on home equity, certain credit cards and other floating-rate loans tied to commercial banks’ prime rate should drop by a corresponding amount. A half-point reduction would leave the prime rate at 4 percent; a quarter-point cut would drop the rate to 4.25 percent. Either way, the prime rate would be the lowest in more than four years.

The Fed hopes lower rates will spur people and businesses to spend again, helping to brace the wobbly economy.

“I think it would be a good-faith psychological move,” said Richard Yamarone, economist at Argus Research.

Earlier this month, the Fed and other central banks joined to slash rates, the first coordinated move of that kind in the Fed’s history. That dropped the Fed’s key rate down to 1.50 percent and marked an about-face in policy. The Fed in June had halted an aggressive rate-cutting campaign that had started in September, aimed at shoring up the economy.

The Fed had moved to the sidelines out of fear that its rate cuts would worsen inflation. Since then the inflation threat has lessened. The threat of a global recession has dampened once-surging prices for energy, food and other commodities.

Now a few economists are starting to worry about deflation — a widespread and dangerous bout of falling prices — if the U.S. and world economy get stuck in a long and painful recession.

The remote but powerful concern about deflation was among the reasons the Greenspan Fed held rates at very low levels for so long in the aftermath of the last recession, in 2001. By the summer of 2003, Greenspan had ratcheted down the Fed’s rate to 1 percent, which was the lowest since 1958. The Fed held rates at those historically low levels for one year before beginning to bump them up to fight inflation.

Critics contend that those low rates fed lax lending standards and the housing bubble that eventually would burst and imperil the economy.

The meltdown drove up foreclosures and forced financial companies to rack up huge losses on soured mortgage investments, laying low storied Wall Street firms and causing banks to fail.