Fed Injects Liquidity To Unfreeze Credit; Markets End Mixed

The Federal Reserve injected $38billion into the banking system in three operations Friday, attempting to avert a credit crunch that could threaten the economy.

The central bank pledged to provide cash as needed "to facilitate the orderly functioning of financial markets."

It was the Fed's biggest one-day injection since it added $81.25 billion shortly after 9-11. The Fed added $24 billion on Thursday.

The news seemed to lift investors' spirits somewhat, though trading was up and down all day.

The Dow, which undercut its Aug. 1 low earlier in the day, closed down just 0.2%. The Nasdaq fell 0.5%. But the S&P 500 finished fractionally higher, while the small-cap S&P 600 jumped 1%.

Many on Wall Street are urging the Fed to cut interest rates quickly. Fed funds futures see a move by the Sept. 18 meeting. But others said policymakers shouldn't bail out financial markets.

Central banks around the world, including Europe, Japan, Australia and Canada, added at least $326.3 billion to the global banking system on Thursday and Friday.

The European Central Bank flooded the system with cash after BNP Paribas on Thursday halted withdrawals from three funds. France's biggest bank said a lack of liquidity made it impossible to fairly value the funds anymore.

Meanwhile, several hedge funds from Goldman Sachs and others reportedly have suffered big losses.

Late Thursday, Countrywide Financial, the biggest U.S. mortgage lender, said "unprecedented disruptions" in the debt and mortgage-backed securities markets "could have an adverse impact" on its earnings and financial condition. Washington Mutual made similar comments.

These and other lenders rely on Wall Street to buy their mortgages in return for cash and credit to make more loans.

Banks have sharply raised rates on jumbo loans and many other mortgage products -- even as Treasury yields decline -- because investors have lost their appetite.

Some analysts say the Fed must quickly cut rates to keep the lending spigot open.

"The Fed needs to wake up. It's time to ease," said Ed Yardeni, president and chief investment strategist at Oak Associates, in his daily note before Friday's open.

Others disagree, saying a rate cut would only bail out those who took excessive risks during the easy credit era of the past few years. That would reinforce investors' belief that the Fed will always be there to rescue Wall Street.

"The Fed should not try to make all the people who were reckless as borrowers and lenders whole by lowering interest rates," said Dana Johnson, chief economist at Comerica Bank.

So far, the Fed has shown no sign of cutting rates despite the turmoil and signs that the economy is slowing. The central bank left rates unchanged at 5.25% on Tuesday.

In its policy statement, the Fed noted for the first time that financial markets have become volatile and that some households and businesses face a harder time getting loans.

But it reiterated its view that the economy will continue to expand at a "moderate pace" and that inflation remained its top concern.

"They're saying in so many words that until they see that this financial market turmoil is affecting the economy, they're not going to do anything," Johnson said.

But just two days later, deepening and widening credit market problems were serious enough to spur some Fed action.

The cash injections came as overnight rates spiked above the fed funds target rate of 5.25%.

Such an increase could force lenders to restrict credit to more creditworthy individuals and companies, damaging economic growth.

"The notion that the Fed shouldn't bail out Wall Street and the hedge funds is ridiculous. There are too many innocent bystanders for the Fed to stand by," Yardeni said.

Banks already have sharply raised rates on jumbo mortgages and other types of loans because they can't sell them to Wall Street.

Banks grabbing Fed liquidity Friday offered mortgage-backed securities as collateral.

The Securities and Exchange Commission is combing through the books of big Wall Street investment banks amid concern that they are hiding subprime mortgage losses, sources said.

Fed funds futures early on Friday even started to price decent odds that policymakers would cut rates this month, before its next scheduled meeting on Sept. 18. The odds of that fell as markets steadied after the Fed's liquidity injection.

"If things deteriorate considerably then there could be an inter-meeting move. I would not foreclose anything now, I think it's day-to-day," said Susan Phillips, dean of the George Washington University business school and a former Fed governor.

Fed funds futures have fully priced in a quarter-point 18ate cut in September -- with a 40% chance that the Fed will cut rates by 50 basis points.

On Wednesday, there was only a 25% chance of a quarter-point cut.

Bernanke's predecessor, Alan Greenspan, was quick to cut rates, sometimes between meetings, in the midst of several financial crises.

These included stock market crashes in 1987 and 2000, and financial shocks such as the savings and loan crisis and the collapse of Long-Term Capital Management at the end of the Asian financial crisis in 1998.

For that, he gained a reputation for helping out financial markets in trouble.

Yet Greenspan has been criticized for keeping rates too low for too long after the dot-com bust and 9-11.

That set the stage for a borrowing binge that sent prices of real estate and other assets soaring. Lenders extended ample credit to borrowers with shaky credit -- and Wall Street eagerly gobbled those loans up. It also paved the way for record debt-fueled buyouts of companies from Chrysler to Hilton Hotels.

Greenspan has said he kept rates low due to fears that the U.S. might fall into a Japan-style bout of deflation, or a continuous fall in prices, that is very difficult to get out of.

"Because the implications for the economy were so dire should that scenario play out, we chose to counter it with unusually low interest rates," he said in August 2005.

Now the era of easy-credit is ending, giving Bernanke his first taste of financial disruption.

"The Fed is not going to cut rates just to bail everybody out. But if it's something that's going to cause a recession then the Fed has an obligation to cut rates," said Jay Bryson, global economist at Wachovia.