Fed Cuts Benchmark Rate to 2.25%, Says `Downside Risks' Remain

By Craig Torres

March 18 (Bloomberg) -- The Federal Reserve cut its main lending rate by three quarters of a percentage point to 2.25 percent as officials try to prop up the faltering economy and restore faith in the U.S. financial system.

``Today's policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity,'' the Federal Open Market Committee said in a statement after meeting today in Washington. ``Downside risks to growth remain.''

Chairman Ben S. Bernanke is struggling to cushion consumers and companies from the worst of the credit freeze that's made some of the world's biggest banks reluctant to lend to each other. The economy, which most analysts say is in a recession, lost jobs in two consecutive months, while retail sales and industrial production are declining.

``The committee will act in a timely manner as needed to promote sustainable economic growth and price stability,'' the Fed said.

The Fed Board of Governors also voted to lower the discount rate, the cost of direct loans from the central bank, to 2.5 percent. Officials reduced the normal 1-point spread over the federal funds rate in August to a half point to ease liquidity constraints. They further narrowed the difference on March 16, in the first weekend emergency move since 1979.

Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented from today's decision, preferring ``less aggressive action.''

Historic Easing

The Fed has cut the benchmark lending rate by 2 percentage points this year, the most aggressive easing since the federal funds rate became an explicit target of policy in the late 1980s.

The decision follows a week of emergency actions by the U.S. central bank, which has pushed its $900 billion balance sheet into the front lines of market turmoil to quell a collapse of brokerage firms and market making in mortgage-backed securities.

``Tightening financial conditions have weakened the growth outlook, and that alone justifies aggressive policy action,'' Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington and a former Fed economist, said before the announcement. The rate action should also help offset ``risks coming from financial market stress,'' he said.

The Fed has lowered its benchmark overnight rate six times and the discount rate eight times since the middle of August, when the collapse of U.S. subprime mortgages started to infect markets around the world. The world's biggest financial companies have posted at least $195 billion in writedowns and credit losses tied to American mortgage markets as of March 14.

Last week, the Fed said it would swap out some of its Treasury holdings for mortgage-linked bonds issued by government-sponsored enterprises such as Fannie Mae and by private companies. On March 14, the Fed extended an undisclosed amount of credit to Bear Stearns Cos. to stave off a collapse, invoking a little-used rule that allows the central bank to loan to non-bank corporations.

Two days later, the Fed expanded on that rule and set up a lending window for dealers in government bonds, similar to the lender-of-last-resort function it has traditionally reserved for banks.

The moves helped relieve some stress in credit markets. Yield differences on a Bloomberg index for Fannie Mae's current- coupon, 30-year fixed rate mortgage bonds and 10-year U.S. government notes narrowed about 22 basis points to 176 basis points, or 61 basis points less than the 22-year high reached two weeks ago.

Still, mortgage lending will tumble to an eight-year low this year and house prices will continue to decline, according to the Mortgage Bankers Association.

Mounting foreclosures are adding to the glut of unsold homes, and that is driving down property values. Home prices in 20 U.S. metropolitan areas fell in December by the most on record. The S&P Case-Shiller home-price index dropped 9.1 percent from December 2006.