Bernanke May Cut Benchmark Rate by Most Since Volcker

March 18 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke may be readying the deepest interest-rate cut in a generation as the central bank struggles to prevent a meltdown in financial markets and a recession.

Traders predict the Federal Open Market Committee, meeting today in Washington, will lower the overnight lending rate by a full percentage point or more, based on futures prices in Chicago. That would be the biggest reduction since 1984, when Paul Volcker led the central bank, and would bring the benchmark rate down to 2 percent.

Policy makers may promise more cuts if needed with a statement that warns of further risks to the economy as the housing recession breeds widening losses among banks and securities firms. The Fed took emergency steps over the weekend to stave off a financial panic, lowering its rate on direct loans to banks and becoming lender of last resort for Wall Street's biggest dealers in government bonds.

``The Fed has moved very aggressively to deal with liquidity problems that are major,'' said former Fed Governor Lyle Gramley, now a senior adviser at Stanford Group Co. in Washington, who said today's reduction may be as much as a full percentage point. ``They need to be aggressive on the monetary policy side. This is the worst crisis we have faced in more than 50 years.''

Shifting Expectations

The severity of the crisis was underscored by the Fed's emergency action on the evening of March 16, the first weekend policy shift since 1979. A week ago, the debate among economists was whether the Fed would cut by 50 basis points or 75 basis points. Now, a reduction of 1 percentage point is seen as a sure bet among futures traders and some anticipate a move of as much as 1.25 percentage points. Either would be the deepest since Volcker's Fed lowered the federal funds rate to 10 percent from 11.75 percent in October 1984.

Treasuries were little changed, with the two-year yield at 1.35 percent at 1:48 p.m. in Tokyo.

Bernanke, whose views on monetary policy were shaped by his scholarly work on the Great Depression, has seen losses at the world's biggest banks and securities dealers balloon to $195 billion since the start of last year, culminating in the collapse last week of the fifth-largest securities firm, Bear Stearns Cos.

Bernanke has failed to calm the turmoil, which his predecessor Alan Greenspan calls the ``most wrenching'' since the end of World War II, even after lowering the overnight rate five times since September and committing to pump an unprecedented $400 billion in cash and securities into the banking system.

Avoiding a Crash

Policy makers have scheduled an announcement at about 2:15 p.m. in Washington.

Bernanke, 54, has already stepped up efforts to keep strains in markets from triggering a crash. The Fed agreed March 16 to help finance JPMorgan Chase & Co.'s purchase of the failing Bear Stearns and the central bank offered last week to lend $200 billion in Treasuries in exchange for debt that includes mortgage-backed securities.

``The Fed will be extremely hesitant to disappoint the markets,'' said Stephen Stanley, chief economist at RBS Greenwich Capital Markets Inc. and a former member of the Richmond Fed staff, who predicts a full percentage-point cut. ``Things are still very fragile. We are in a situation where credit tightening has started to feed on itself, and it has real economic implications.''

Recession Signals

Recent economic data suggests the first recession since 2001 may have begun in December or January. Harvard University economist Martin Feldstein, a member of the committee that officially declares when a recession has started, said last week that he believed a recession was under way and it could be the most severe since World War II.

``They are worried about the spillover effects of financial markets and what they can do to keep that from happening,'' said Robert Eisenbeis, former research director at the Atlanta Fed who is now chief monetary economist at Cumberland Advisors Inc. in Vineland, New Jersey.

The economy expanded 0.6 percent at an annualized pace last quarter and economists surveyed by Bloomberg News this month predicted the pace will slow to 0.1 percent in January to March.

``Bernanke believes the economy is in a very serious situation right now,'' said Paul Kasriel, director of economic research at Northern Trust Co. in Chicago. ``The Fed is worried about a very severe credit contraction that can cause an even weaker economy.''

Fed's Forecast

Fed officials lowered their projections for economic growth by half a percentage point this year, according to quarterly figures published last month.

Fed Governor Frederic Mishkin said March 4 that the economy may face an ``adverse feedback loop,'' where tightening credit and a declining economy create a cycle that leads to further deteriorating conditions. The FOMC discussed that possibility during the January meeting, according to its minutes.

``The overriding concern is the condition of the financial markets.'' said William Ford, former president of the Federal Reserve Bank of Atlanta and now chairman of the finance department at Middle Tennessee State University. ``They are fighting a financial panic and want to preserve orderly markets.''