April 19, 2001

                Major Business News

                Half-Point Rate Cut Shows Fed's Balance Between Reliance on Economy,Markets

                By GREG IP and JACOB M. SCHLESINGER
                Staff Reporters of THE WALL STREET JOURNAL

                WASHINGTON -- For the past five months, Alan Greenspan
                has been attempting a delicate balancing act. He has been
                striving to show that he is concerned about the economy's
                weakness. Yet he has also been trying to demonstrate that
                he isn't out to prop up the stock market.

                On Wednesday the Federal Reserve chairman unveiled the
                latest move in that complex strategy: a surprise
                half-percentage point reduction in short-term interest rates.
                For weeks, he has taken withering criticism from investors,
                commentators and even normally circumspect former Fed
                colleagues, who argued that he was behind the curve. Their
                attacks rested in part on financial markets that were plunging
                on the lack of faster Fed action.

                Mr. Greenspan soaked up the censure
                and waited until a day when investors
                had all but ruled out further rate relief
                this month -- and when the stock market
                was already rallying. He convened an
                8:30 a.m. conference call with his
                colleagues and put through the cut, the
                Fed's fourth big move this year.

                While striving to avoid the appearance of
                bailing out financial markets, the Fed
                chairman does try to use them to further
                his cause, especially by giving out
                pleasant surprises from time to time. By
                that score, Wednesday's act was a big
                success, as markets turned giddy after
                the 11 a.m. announcement. The Dow
                Jones Industrial Average ended the day
                up 399.10 points, or 3.9%, and the
                Nasdaq Composite Index rallied 156.22,
                or 8.1%.

                The action lowered the Fed's target for
                the federal-funds interest rate, which
                banks use on overnight loans to each
                other, to 4.5% -- the lowest level in
                seven years, capping a breathtaking
                sprint to lower rates. The reduction of
                two full percentage points since New
                Year's Day is the most the central bank
                has implemented in so short a time in 16
                years, according to Merrill Lynch. The Fed
                on Wednesday also cut its largely
                symbolic discount rate by half of a
                percentage point to 4%. Major commercial banks followed by
                cutting their prime rates to 7.5% from 8%.

                Many economists think the Fed still has more work to do,
                which the central bank doesn't seem inclined to dispute. Its
                statement expressed concerns of continued "risks" of
                "economic weakness." The futures market that bets on Fed
                action is pricing in a Fed funds rate as low as 4% by July.

                Wednesday's move wasn't a response to any sudden
                deterioration in the economy. Indeed, the explanatory
                statement released with the announcement noted that since
                the Fed's last meeting in March, the liquidation of excess
                business inventories was "well advanced" and "consumption
                and housing expenditures have held up reasonably well." Just
                Tuesday, the Fed reported that industrial production
                unexpectedly rose in March, following five months of
                contraction.

                That was also in keeping with the Greenspan tactic of
                preferring to avoid the appearance of reacting to any one
                specific piece of data. Rather, the Fed is responding to an
                accumulation in recent months of still-real threats to
                economic recovery: The statement cited weak profits and
                business investment, the hit to consumer spending from
                shrinking stock wealth, and concern about "slower growth
                abroad."

                The true depth of the economy's current problems and the
                prospects for a swift turnaround hinge in large part on
                psychology. If businesses and consumers take heart from the
                latest Fed action by spending more, the worst could be over
                and the need for further Fed action limited.

                Mr. Greenspan's tactics over the past few months reveal
                much about how he has carefully attempted to manipulate
                the mindset of markets, companies and consumers. He has
                been determined to make sure that he is moving markets,
                and not the other way around. That is why he has repeatedly
                refused to show signs of easing when the market was
                plunging and many economists and investors were calling for
                it. It's also, however, why he has twice chosen to take
                traders by surprise to push through his rate cuts, thus
                magnifying the market response.

                It was early last fall that Fed officials first began to pick up
                hints and complaints that their yearlong campaign to cool the
                super-charged U.S. economy with rate hikes may have
                succeeded a bit too well. In October, Robert McTeer,
                president of the Federal Reserve Bank of Dallas, was a guest
                speaker at a board meeting of the National Association of
                Manufacturers. Over lunch, the association's president, Jerry
                Jasinowski, told Mr. McTeer manufacturers were being hit by
                a "perfect storm" of high interest rates, a high dollar and
                high energy costs.

                Over the next five weeks, other troubling signs emerged,
                including falling computer stock prices and rising yields on
                junk bonds. When officials gathered for their Nov. 15
                monetary policy meeting, they agreed that there was now
                solid evidence of an "appreciable slowing in the expansion of
                economic activity," according to minutes of the meeting.

                Yet there was still no serious discussion of cutting interest
                rates soon. After all, this was a slowdown the Fed had
                eagerly sought. Some members remained concerned about
                tight labor markets, while others were worried that the sharp
                rise in oil prices could spark inflation.

                Avoiding an Unhealthy Rally

                While Wall Street was turning increasingly bearish, Fed
                officials at that November meeting were still more worried
                about yet another unhealthy rally than they were about a
                destabilizing crash.

                              The Fed has two main policy tools at its
                              disposal at each meeting. The first is its
                              target for short-term interest rates. Officials
                              agreed that no change was warranted at the
                              November session. The second tool is a
                              short statement on the Fed's economic
                              outlook. Over the past two years, Mr.
                              Greenspan has become increasingly
                              aggressive about using that to signal
                              markets where rates will be heading in the
                              future. Each statement ends with a "bias" --
                              a declaration that the Fed sees the greatest
                              risks to the economy tilted toward inflation,
                toward recession or evenly balanced between the two.

                The economic data discussed at the meeting seemed to
                warrant declaring the risks fairly even. But Mr. Greenspan and
                others were against dropping the inflation bias the Fed had
                maintained for the past few months. Doing so, some officials
                feared, would build false hopes for quick rate cuts and spark
                a market rebound that would make it harder to keep at or
                below the economy's speed limit.

                Fed officials were careful not to mention markets in such
                explicit terms. But according to their minutes, they expressed
                concern that a change in bias could have produced
                "undesirable softening in overall financial market conditions,"
                which is Fed-speak for rising stock prices, falling bond yields
                and easier bank lending standards.

                After Thanksgiving, however, Mr. Greenspan started talking
                more bearishly about the economy in public. He used a
                speech before community bankers on Dec. 5 in New York to
                signal the shift in his concerns. Previously, he had lauded
                corporate America's tech-spending binge as proof of its faith
                in technology's productivity-boosting potential. Now, he
                acknowledged, "The current shake-up in some segments of
                the telecom and other high-tech sectors" reflected "some
                overreaching." He noted the rise in junk bond yields as well
                as banks' tightened lending standards and urged bankers not
                to go too far in restricting credit from creditworthy
                businesses.

                Then the bottom fell out.

                In the second week of December, Mr. Greenspan and his
                colleagues suddenly started getting swamped by calls from
                business executives warning them that orders were abruptly
                drying up.

                One was Lyle Gramley, a former Fed governor who now does
                consulting for institutional investors. He had been on the
                road shortly after Thanksgiving, briefing clients on the state
                of the economy. The message he carried to them was that
                the economy was still chugging along at a healthy clip. But
                they offered a warning, he recalls: "You're out of date -- the
                economy's deteriorating faster than you're talking about." As
                soon as Mr. Gramley returned to Washington, he called David
                Stockton, the Fed's head of research to pass on the
                impression.

                Fed researchers worked the phones, conducting their own
                confidential up-to-the-minute surveys of sentiment among
                businesses around the country, and the news they were
                feeding back to Mr. Greenspan was that pessimism was
                taking root fast.

                On Dec. 13, Mr. Jasinowski and W.R. Timken Jr., CEO of
                bearing and steelmaker Timken Co. and chairman of the
                National Association of Manufacturers, wrote a letter to Mr.
                Greenspan urging the Fed to cut rates ASAP: "Unless action
                is taken promptly, we believe that the sharp slowdown in the
                economy could lead to an economic contraction and
                significant employee layoffs."

                By the time the Federal Open Market Committee met again
                Dec. 19, members knew it was time to shift gears. But how
                much? Some, including Fed Gov. Edward Gramlich, were ready
                to cut rates on the spot. But most members were uncertain
                economic conditions justified that. Mr. Greenspan also was
                opposed, for tactical as well as economic reasons. The Fed,
                by shifting its bias all the way from inflation to economic
                weakness without pausing at "neutral," would do a lot to
                alter market psychology, officials reasoned, and saving the
                rate cut for later would enhance the total impact.

                Mr. Greenspan is a master at finding compromise between
                anti-inflation hawks and New Economy doves, believers eager
                to prop up growth. The compromise at that meeting was to
                change the bias but, if sentiment didn't pick up soon,
                convene before the scheduled late January meeting and cut
                rates then. Many officials left the cavernous boardroom that
                day convinced they'd all be talking again very soon.

                The economic mood didn't pick up
                in December. The Fed's informal
                surveys of business leaders still
                showed deteriorating conditions.
                Mr. Greenspan began the last
                week of the year with more
                gloom. Late on the day after
                Christmas, he and then-Treasury
                Secretary Lawrence Summers
                convened for more than an hour
                at the Fed with California Gov.
                Gray Davis, who was giving them
                a briefing on his state's mounting
                electricity crisis. The Fed
                chairman also got a private
                advance glimpse that week at the
                downbeat manufacturing index
                from the National Association of Purchasing Management to
                be released Jan. 2.

                Many officials were expecting Mr. Greenspan to call for a
                move the first week of the year but were betting that the
                most likely time would be Friday, the day the December
                employment report was to be released. One official, slated to
                be out of town that day, even made special arrangements
                with the local Fed office to be ready to participate in the
                meeting by phone.

                But Mr. Greenspan chose Wednesday, Jan. 3, instead, in
                order to maximize the market surprise. And in a symbolic
                move underscoring internally and externally that
                once-hesitant officials were united behind the decision, the
                Fed chairman called a formal vote on the question. It was a
                small gesture, not required by the Fed's by-laws. Officially,
                the Fed chairman has the power to act between meetings
                without calling a formal roll call.

                At first, the rate cut seemed to dramatically dispel the
                pessimism then encircling markets and the economy. The
                Nasdaq composite rocketed 325 points, a record 14%, while
                the Dow Jones average soared almost 300 points. The rally
                continued for most of the month. The Fed followed up with
                another widely expected half-point cut at its regularly
                scheduled Jan. 31 meeting.

                But what followed over the next couple of months was an
                uncomfortable dance between financial markets and the
                central bank. Fed officials parsing the data from the real
                economy felt that things weren't actually that bad. The Fed's
                internal surveys of business leaders had stabilized. Consumer
                spending on houses and cars, in particular, was holding up
                remarkably well in spite of falling confidence. Mr. Greenspan
                told Congress twice in February that the severe weakness of
                late 2000 did not seem to have continued in early 2001.

                Mixed Signals

                Even some of the business executives who were struggling
                didn't show alarm when they met with the Fed. In early
                March, Mr. Greenspan appeared before the board of the
                Semiconductor Industry Association. Executives were
                downbeat, but not as much as might have been expected,
                recalls Wim Roelandts, a board member and chief executive
                of chip maker Xilinx Inc. "This is our third recession in the
                last five years. It is a very cyclical industry. We are maybe
                more used to that and less panicked than some other
                industries."

                But Wall Street was panicking. During February and into early
                March, a tidal wave of profit warnings sent stocks plunging to
                fresh lows, wiping out the entire post-Jan. 3 rally. And the
                worse that stocks performed, the more that markets began to
                hope -- and assume -- that the Fed would act to bail them
                out. Stock prices, not economic news, became the primary
                influence over bets on Fed actions. In late February, the
                speculation hit a fever pitch when Bear Stearns chief
                economist and former Fed governor Wayne Angell put high
                odds that the Fed would cut rates before its next meeting.

                When the Fed didn't deliver the intermeeting cut, a new
                market feeding frenzy emerged in the days before the March
                20 session. While the Fed was clearly ready to make another
                half-point cut, calls were growing for an even more dramatic
                three-quarter-point reduction, a move unseen since the
                depths of the early 1980s recession.

                "I was getting a lot of advice before the meeting," from
                neighbors and business contacts, Federal Reserve Bank of
                Richmond President J. Alfred Broaddus recalled in an
                interview earlier this month. Mr. Broaddus was not a voting
                member of the Fed's open market committee, but like all
                regional presidents is an active participant in all their
                meetings. A few days before the meeting, Mr. Broaddus was
                riding the elevator down in his office building when another
                employee got on. He "didn't say anything until I got down to
                the bottom, and when he got off the elevator he looked
                around to me and said, 'Do three-quarters,' " Mr. Broaddus
                recalls.

                Ready to Deliver

                Some officials came ready to deliver that, especially with
                participants mindful that if they didn't, shaky financial
                markets would almost certainly plunge. Yet as Mr. Greenspan
                led off the policy discussion that morning from his brown,
                padded-leather swivel chair, he told colleagues he favored
                the more modest half-point cut. Several others echoed his
                points. For one thing, many noted, the data on the real
                economy -- as opposed to the stock market -- wasn't so bad
                and actually appeared to have steadied.

                Besides, officials believed that responding to market
                expectations was a dicey game. If the Fed came through with
                a three-quarter-point cut that day, investors would be
                demanding an even bigger one the next time around. And
                there was a real risk that markets would fall even if the Fed
                did provide the big cut. Then the central bank's credibility in
                battling the recession threat could be more seriously
                damaged, some members worried.

                Mr. Greenspan and the moderates prevailed in the debate.
                When the formal decision was announced about an hour after
                the meeting broke up, the stock market, as expected, began
                to tumble.

                The Nasdaq finished the day down nearly 5%, while the Dow
                Jones industrials lost more than 2%. The carnage continued
                over the next two days. Between its midday high Tuesday
                and the afternoon low Thursday, the Dow dropped more than
                900 points, or 9%, at one point falling enough to have
                marked the end of its decade-long bull market, though a
                late-day bounce intervened.

                Waiting for the Impact

                Officials insisted that if a three-quarter-point cut had been
                justified by economic conditions they would have done it,
                regardless of the market. Nor did they ignore the stock
                market, which not only conveys a lot of information about the
                profit outlook but has real effects on consumers via wealth
                and confidence. "You could have made a case" for
                three-quarters of a point, Mr. Broaddus says, "But monetary
                policy affects the economy with a lag." Consumer spending
                seemed to be holding up better than many expected in the
                first quarter, he noted. "We had already moved the funds
                rate and discount rate down a full percentage point before
                that meeting, and we hadn't necessarily seen the full impact
                of that."

                For Mr. Greenspan, the March meeting was also the latest
                stage in a complex attempt to grapple with monetary policy
                in an age of outsized financial markets. After his famous
                1996 "irrational exuberance" speech and long soul-searching,
                Mr. Greenspan decided against pricking the bubble on the
                way up. Now, he had ruled out as futile, counterproductive
                even, trying to keep it from collapsing on the way down.

                Over the next few weeks, Fed officials -- though not Mr.
                Greenspan -- hit the road to explain the controversial move.
                "Fed policymakers must stand apart from the incessant
                demand for instant reaction and the expectation of instant
                results," Philadelphia Fed President Anthony Santomero
                declared the following week. Atlanta Fed President Jack
                Guynn declared in a speech earlier this month, "Monetary
                policy is not the tail that wags the bull -- or the bear, for
                that matter. Stock prices are ultimately determined by the
                fundamentals of the overall economy -- and not the other
                way around."

                And yet Fed officials have also come to realize that if it they
                catch the market by surprise, they can get big market
                movements that amplify the impact on financial conditions,
                through what insiders call "the announcement effect."

                Indeed, some officials actually enhanced the announcement
                effect by playing down the prospects of an intermeeting cut.
                Speaking to reporters April 10, St. Louis Fed President
                William Poole even seemed to rule out an imminent cut.
                Acknowledging that "there has been a lot of discussion
                about" intermeeting rate cuts, Mr. Poole said "there are
                compelling times when quick action is necessary, but this is
                not one of them." By earlier this week, markets that bet on
                future Fed action had ruled out any cut before the next
                meeting, scheduled for May 15.

                Then came Wednesday's move.

                Write to Greg Ip at greg.ip@wsj.com and Jacob M.
                Schlesinger at jacob.schlesinger@wsj.com