WASHINGTON – All eyes are on the Federal Reserve Tuesday as its policy-making committee tries to spark the sick U.S. economy back to health, slashing short-term interest rates by what Wall Street believes may be a full percentage point.

As recently as Friday, investors were signaling that they expected the Fed to cut rates by half a percentage point. But that was before the spectacular weekend collapse of investment bank Bear Stearns, whose value stood at $3.5 billion on Friday before it was sold Sunday night for just $236 million to JPMorgan Chase after a run on it by investors.

The Fed brokered the $2-a-share sale of Bear Stearns. Shares of JPMorgan Chase, which purchased it, rose 11 percent on Monday, pulling the Dow Jones Industrial Average into positive territory. The Dow closed Monday up 21.16 points to 11,972.25.

Sunday night the Fed also widened access to credit like never before in a muscular bid to keep banks and other institutions lending and corporations and investors borrowing.

“These moves by the Fed are a prelude to additional bold action to reduce rates,” said Brian Bethune, U.S. economist with forecaster Global Insight in Lexington, Mass. He predicted a full percentage-point cut.

Wall Street is all but certain that a cut of at least three-quarters of a percentage point is coming and hopeful for a full percentage point, which would put the Fed’s bellwether short-term “federal funds” rate at 2 percent. That would bring the prime rate, which banks charge to their best customers, down to 5 percent.

“We continue to expect the funds rate eventually will reach 1.5 percent,” said Mickey Levy, chief economist of Charlotte, N.C.-based Bank of America, in a note to investors.

What such low interest rates would mean for consumers isn’t clear, since turmoil in the credit markets means that banks aren’t lending. Instead, they are hording capital to shore up their balance sheets.

Lower rates could bring down some variable rates on credit cards, but credit card companies have been raising rates out of fear that the economic downturn will lead to more loan defaults.

The falling rates could help ease the sting for homeowners whose adjustable-rate mortgages are about to reset higher. But many of these loans adjust based on factors not directly affected by the Fed’s benchmark rate.

The Fed has already cut the funds rate from 5.25 percent last September to 3 percent in January. So far that’s done little to revive the U.S. economy, which has been in increasing turmoil since August.

The Fed has also made available more than half a trillion dollars in credit to banks and securities dealers in hopes of spurring lending and preventing credit markets from seizing up.

There were glimmers of hope Monday as the difference between yields on mortgage bonds and other safer financial instruments – called the spread – narrowed. One day does not make a trend, but it’s a possible sign that the fear gripping credit markets could be easing.

“These areas have tended to lead other areas of credit, so if we can hold onto these recent gains, there should be improvement in the tone of risk in general,” said Michael Darda, chief economist for MKM Partners, a stock trader and research firm in Greenwich, Conn.

Lyle Gramley is less optimistic. He’s a former Fed governor and has spent more than 50 years studying financial markets.

“If you look back at post-war recessions, I thought I knew that when the Fed pushed the accelerator, we’d leave problems behind. We just don’t know that now – that’s one of the most scary parts of the situation that we find ourselves in,” Gramley said. He believes that taxpayer dollars and more government intervention are needed.

President Bush and Treasury Secretary Henry Paulson have made clear that they’ll oppose bailouts of lenders. In a brief statement after meeting with his economic team on Monday morning, Bush said, “One thing is for certain, we’re in challenging times. But another thing is for certain: We’ve taken strong, decisive action.”

Overseas stock exchanges took heavy losses Monday, particularly in Asia, spooked by the sudden fall of Bear Stearns.

But a similar rout on U.S. stocks was averted. After falling almost 200 points at the start of trading, the Dow Jones Industrial Average turned positive in the final hour to close up 21.16 points. The S&P 500 was down 11.54 points to 1276.60 and the Nasdaq closed off 35.48 to 2177.01.

Oil prices fell $4.53 a barrel to $105.68 on fears of a deep U.S. economic slowdown, the largest one-day drop in 17 years.

Monday could have been a far different day if not for bold action by the Fed to broker the sale of Bear Stearns in order to prevent its bankruptcy.

“To allow this to go to bankruptcy would have allowed systemic problems that could have been massive,” Senate Banking Committee Chairman Christopher Dodd, D-Conn., said in a conference call to U.S. reporters from Belgium.

The Fed on Sunday night also made a quarter-point cut in its discount rate, which it charges as the lender of last resort to banks. It extended the loan repayment time frame to 90 days from the normal 30-day terms, accepted as collateral a broad range of financial instruments including mortgage bonds, and made credit available to not just investment banks but also securities dealers.

Although U.S. stocks averted disaster Monday, share prices for financial sector players were hammered as concerns persisted about whether other big players were vulnerable to a run by investors, as Bear Stearns was.

“You know the old saying about cockroaches, there’s never just one,” said Howard Simons, president of Rosewood Trading, an economic research firm in Glenview, Ill. “One thing we’ve learned the hard way over the past year is, just when you think there’s no more bad news, there’s more bad news.”

Leading decliners was investment bank Lehman Brothers, which like Bear Stearns bet heavily on mortgage bonds that are now toxic. Lehman shares fell by 19 percent, following a 15 percent fall on Friday. Shares of Morgan Stanley fell 8 percent, Citigroup 6 percent, Merrill Lynch 5.4 percent and Goldman Sachs 3.7 percent.

The Fed is buying time and hoping for resuscitation of the housing market, whose problems started the credit crunch. Dodd and others in Congress are looking for methods of government intervention that would stop short of a bailout to lenders, and feel the administration may go along.

“I think they’re far more supportive of the idea, or something like it, than they were a while ago,” said Dodd.

Gramley, the former Fed governor, also believes action is needed now.

“It’s going to require some taxpayer money. I think the sooner we move, the less it’s going to cost,” he said.

When J.P. Morgan Chase & Co. agreed Sunday night to buy beleaguered investment bank Bear Stearns to help quell panic in the financial world, it was living up to its legendary founder, John Pierpont Morgan.

Morgan, considered the greatest financier in U.S. history, single-handedly rescued America’s financial system during a similar panic on Wall Street in 1907.

There was no Federal Reserve in 1907. The Dow Jones Industrial Average lost 39 percent of its value between March and October that year. On Oct. 21, a run by depositors withdrawing funds led the Knickerbocker Trust Co. bank to close the next day and its president to shoot himself to death soon after.

That bank failure led Morgan, a private banker, to organize a bailout fund for other Wall Street concerns. Working with President Theodore Roosevelt’s Treasury Department, a $25 million federal fund was assembled to keep the system from collapsing. That helped, but it wasn’t enough.

Morgan next organized a second $3 million private pool to save the Trust Co. of America from collapse. Finally, on Oct. 24, the president of the New York Stock Exchange told Morgan that the exchange couldn’t stay open through the day unless Morgan gave it a bailout fund. Morgan arranged a second $25 million private pool that day. When it was announced, the NYSE trading floor exploded into an ovation and the crisis ended.

For all this, Morgan was hailed as the savior of the banking system.

Sources: Brian Trumbore, president/editor, StocksandNews.com, “The Great Game” by John Steele Gordon, and Diane Lindstrom, professor of history, University of Wisconsin-Madison.


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