Fed leaves investors hungry for more

WASHINGTON - Trying to rescue an economy tied to a sinking housing sector, the Federal Reserve on Tuesday threw out another lifeline -- a quarter-point interest rate cut, the third since September.

But many investors had wanted a more dramatic cut, and when they didn't get it, they sold off stocks furiously. That drove down the Dow Jones industrial average 294.26 points to 13,432.77.

The Fed cut the benchmark federal funds rate to 4.25 percent to "help promote moderate growth over time" by reducing borrowing costs enough to stimulate growth and offset the housing slump.

In a statement accompanying its 9-1 decision, the Fed left the door open to further cuts in coming months.

It expressed concern that "growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending." In addition, "strains in financial markets have increased in recent weeks," it said.

Banks immediately followed the Fed's lead, cutting the prime interest rate by a quarter percentage point to 7.25 percent. Banks charge their best business customers the prime rate and use it as a peg for setting all sorts of lending rates. Tuesday's rate reduction will ripple out in the form of cheaper home equity loans, credit cards, car loans and more.

The Fed also lowered the so-called discount rate, which it charges banks for short-term loans, by a quarter of a percentage point to 4.75.

The Fed has been more restrained in its rate-cutting than many stock investors would like because it wants to avoid stimulating the economy too much while energy and commodity prices still are high. The Fed said that because "some inflation risks remain," it must make sure demand for workers, goods and services doesn't run too hot.

A few economists think the Fed is not taking the threat of inflation seriously enough. For Rich Yamarone, an economist for Argus Research Corp., issued an analysis Tuesday saying that with food and fuel prices continuing to rise and consumers still shopping, "the Fed decision to lower rates seems a bit irresponsible."

But many economists think the opposite, saying the Fed has been too slow to respond to a slumping economy. Some even think the economy already is tumbling into an official recession, defined as two consecutive quarters of falling gross domestic product.

On Monday, Morgan Stanley issued a recession alert, saying it expects a dramatic slowdown in business investment as the housing market's problems spread.

"As delinquencies and defaults soar, lenders are tightening credit for commercial, credit card and auto lending, as well as for all mortgage borrowers," the bank's chief U.S. economist, Richard Berner, said in his written report.

Other economists still hold out hope that gross domestic product, the total of all goods and services, won't face six straight months of shrinking.

The last time the Fed cut rates, it warned borrowers they shouldn't assume more cuts would be coming because the risks from recession and inflation were roughly balanced. This time, economists widely interpreted the Fed statement, with its focus on "deterioration" of financial conditions, as an indication that more cuts will be coming in early 2008. The next policymakers' meeting is scheduled for Jan. 30.

While economists are split over the severity of the slump, political leaders are divided over what they should be doing about it.