Financial bonanza

Stocks around the globe plunged again Tuesday as central bankers around the world rushed to bolster deteriorating financial institutions and restore lending to companies that are cutting back because they are frozen out of credit markets.

In the United States, the Federal Reserve took the extraordinary step of saying it would directly buy the short-term debts of businesses locked out of frozen credit markets. Its chairman, Ben Bernanke, also signaled the central bank may soon cut interest rates because the "severe financial instability" the country is now experiencing "can take a heavy toll on the broader economy, if left unchecked."

The Dow Jones industrial average lost 508 points Tuesday, mostly in late trading as news surfaced that the British government is preparing to spend as much as 50 billion pounds to rescue that nation’s leading banks. The Dow closed down more than 5 percent, at 9,447.11, and is now at its lowest level in five years.

The financial situation around the world appears to be worsening despite a series of extreme, if disjointed, measures by governments to contain the problems, including the passage last week by the U.S. Congress of a $700 billion bailout of banks and other firms burdened by toxic mortgage-related loans.

"Once you get behind the curve, it’s a very nasty situation to bring back under control," said Brian Bethune, chief U.S. financial economist for Waltham-based Global Insight. "It’s like a nuclear reactor that starts to melt down and you go into higher levels of emergency response to try to control it."

Tuesday’s developments unfolded as financial leaders used increasingly stark terms to describe the peril the U.S. and global economies face if the breakdown in financial systems isn’t arrested.

In Boston on Tuesday, Duncan L. Niederauer, the chief executive of the New York Stock Exchange, asserted that the refusal by investors to make even routine, short-term loans to businesses has been a crucial blow to the economy.

"The credit markets have finally tipped us over into a recession," Niederauer said to a lunchtime audience of Boston College’s Chief Executives’ Club. "If we don’t get the credit markets open, I’m afraid it’s going to be dire."

The Fed sought to do just that Tuesday. In a move that essentially makes the central bank the business lender of last resort, the Fed said it would buy enormous amounts of corporate commercial paper, the short-term loans that are the lifeblood of businesses. The intervention was prompted by a near-paralysis in the nation’s credit markets, which businesses rely on to fund basic operations, such as paying workers and suppliers (pay day loans).

Such credit has become increasingly expensive, if available at all, as the investors who normally buy those loans have been spooked by the rapid deterioration in the financial system and are unwilling to stomach any risk those loans would go bad. Meanwhile, banks are also more reluctant to lend, choosing instead to preserve capital in case they are hit with unanticipated losses.

The Fed’s action came just a day after it increased a short-term loan program for banks to as much as $900 billion by the end of the year — exceeding even the government’s $700 billion bailout plan enacted on Friday.

"Almost every day there’s a new program. It’s almost Rooseveltian, if that’s a word," said David Jones, chief economist at DMJ Advisors in Denver and a longtime Fed watcher. He was referring to bold federal programs undertaken by President Franklin D. Roosevelt in the 1930s to battle the Great Depression.

"Certainly, the Fed is pressing against the bounds of its territory as the central bank. But we got into the Depression precisely because the Fed then stood by and watched most of the banking system fail, watched the money supply contract by a third, and did nothing about it. You cannot criticize this Fed for trying to do something about a crisis which has basically shut the flow of credit down to a trickle and poses a threat to the economy," Jones said.

In a speech in Washington on Tuesday, Bernanke acknowledged that the Fed and U.S. government have taken "momentous steps" to combat "a problem of historical dimensions." But he also appeared to concede that the combination of measures would still not be enough to immediately reverse the slide in the economy.

"All told, economic activity is likely to be subdued during the remainder of this year and into next year," Bernanke said. "The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth."

Despite the Fed’s actions, credit markets remained mixed Tuesday, with one key corporate lending rate dropping substantially, while others spiked ever higher, indicating banks and other lenders are still nervous about funding loans.

The Associated Press contributed to this report.

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