Stocks Sag Despite Fed's Flag-Waving

Updated from 8:30 a.m. EDT

The Fed did its best Monday morning to restore investor confidence, but it fell short of fulfilling that tall order.

Seeking to ensure that the capital markets remain liquid, the Fed cut its closely watched fed funds rate to 3% from 3.5%. But U.S. stocks, trading for the first time since Tuesday's terrorist attacks on New York and Washington, registered steep declines. The Nasdaq fell nearly 100 points, or 5.7%; the Dow Jones Industrial Average and the S&P 500 also dropped, though less precipitously.

The Fed has cut interest rates eight times this year as growth has slowed. With many observers fearing that the Sept. 11 attack on the World Trade Center would thrust the staggering economy into recession, the Fed moved to supply banks and companies with money to return to business as usual.

"The Federal Reserve will continue to supply unusually large volumes of liquidity to the financial markets, as needed, until more normal market functioning is restored," said the FOMC in a statement that followed the cuts. "As a consequence, the FOMC recognizes that the actual federal funds rate may be below its target on occasion in these unusual circumstances."

The rate-cutting effort is seen not just as an effort to bolster confidence following the attacks, but as an attempt to help monetize rebuilding costs. In a statement Friday, the Fed urged banks to work directly with customers that have been affected by the attacks. Today's injection of liquidity into the economy gives them the wherewhithal to do that.

With markets opening for the first time in a week, the cut was widely expected.

"It didn't come as a huge surprise," says J.P. Morgan Chase financial economist Marc Wanshel. "Obviously, there's a coordinated effort in all of government to restore confidence."

Yet it is doubtful that confidence will get any better in the short run. As a result, the economy is now widely expected to contract in the third and fourth quarters, entering its first recession since 1991.

That recession came in the midst of the Gulf War. There are obvious parallels. As with then, confidence, and markets, will likely not rebound, thinks Miller Tabak bond strategist Tony Crescenzi, "until there's a sense the crisis has been defused."

"People will be anxious and nervous," he says. "Especially New Yorkers. This is much too close -- it seems everyone knows someone."