January 24, 2008 / 11:00 PM / 11 years ago

Fed says was unaware of SocGen losses

WASHINGTON/CHICAGO (Reuters) - The Federal Reserve, when it decided on an emergency interest rate cut this week, was unaware of a scandal involving a rogue trader that led to about $7 billion in losses at France’s Societe Generale, a Fed official said on Thursday.

The entrance to the headquarters of French bank Societe Generale is seen in La Defense, outside Paris, January 24, 2008. Societe Generale has uncovered a fraud by one of its traders which will have 4.9 billion euros ($7.16 billion) negative impact on the group France's second largest listed bank. REUTERS/Benoit Tessier

Still, the heavy losses at SocGen (SOGN.PA), France’s second-biggest bank, dealt a blow to the Fed’s credibility in the eyes of some financial market participants, who wondered if policy-makers blundered in making the biggest U.S. interest rate cut in a generation on Tuesday.

“Their panicky rate cut was not to insure the smooth functioning of the markets, but rather, to guarantee prices,” said Barry Ritholtz, a market analyst at Ritholtz Research & Analytics.

“We quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices,” Ritholtz wrote on his blog, The Big Picture.

The U.S. central bank on Tuesday morning stunned markets by slashing overnight borrowing costs by three-quarters of a percentage point, to 3.5 percent. The cut came a day after a global stocks rout and just a week ahead of the Fed’s next scheduled policy meeting. U.S. markets, closed on Monday for a holiday, were set to reopen when the Fed acted.

Initially, analysts attributed the swoon in global markets exclusively to worries about the possibility of a global meltdown triggered by mounting U.S. economic problems. But on Thursday, after SocGen said it had tried to close out rogue positions on Monday, some analysts said the bank’s sales may have played a big role in the day’s sell-off.

The re-evaluation led traders to ratchet back expectations for another big rate reduction at the U.S. central bank’s January 29-30 policy meeting.

The SocGen blowup “suggests more big rate cuts near term might not be so necessary,” said strategists at Action Economics.

The chances of a half-point rate cut, as implied by interest-rate futures prices, fell as low as 58 percent after being fully priced in late on Wednesday.

CHANGE IN RATE PATH?

Even though the losses at SocGen have come to light, the Fed official, who spoke on the condition of anonymity, said policy-makers remain comfortable with their decision to cut rates aggressively.

When policy-makers held an emergency video-conference on Monday night, they felt financial market volatility — including, but not limited to, broad stock market declines on Monday — reflected underlying concerns about the broad economy, the official said. They did not consider the volatility to be due to the problems of any single institution, the official added.

Policy-makers were clear at their meeting that the benchmark federal funds rate was higher than they wanted, the official said. The risks of waiting for the next scheduled policy meeting before acting outweighed the downside of any criticism the Fed might incur for an inter-meeting change that could be seen as a response to market events, the official added.

Fed officials were convinced the sizable rate cut so close to a scheduled meeting would make clear to markets the U.S. central bank’s willingness to address the most serious risks, the official said.

Editing by Dan Grebler

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