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Prime-Rate Dominoes Falling

Bank of America blinks, and an unprecedented 24 hours of defying the Fed ends for U.S. banks.

A daylong campaign by the nation's biggest banks to defy the

Federal Reserve

and hold the line on interest rates came to an end late Thursday when

Bank of America

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said it would drop its prime rate to 4%.

The nation's third-largest bank became the first lender to reduce its prime rate from 4.25% in the wake of the Fed's quarter-point cut. The Charlotte, N.C.-based bank took the action shortly after the close of the trading day. Moments later, Chicago-based

Bank One

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took a similar action. Others are expected to quickly follow suit.

We Were Soldiers

For a time, it looked as though the banking industry would successfully send a message to the Federal Reserve expressing unease with the Fed's latest interest rate cut on Wednesday.

For an almost unprecedented 24 hours, the nation's major banks refused to bow before Washington and trim their prime. Banks usually move to reduce the prime rate -- the interest they charge their best customers -- within hours of a Fed move.

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"It's not something we've seen in any of the prior rate cuts to this point," said Greg McBride, a

analyst. "It's surprising they have taken this course of action."

The Fed funds rate, the interest banks charge each other on overnight deposits with the Federal Reserve, is 1% after Wednesday's action. The move is designed to pump liquidity into the money system but would've been stripped of some efficacy if major commercial banks didn't follow suit.

The Fed cut was the 13th by the nation's monetary policy makers and maybe the most controversial. That's because many banks are already feeling the pinch of the previous easings. While the Fed cuts have spurred a boom in home mortgage lending and refinancing, the low rates also are eating into the profit margins of many banks' lending operations.

Money Crunch

The conventional wisdom is that a Fed rate cut is good news for the nation's banks because it spurs more consumer borrowing and reduces banks' own borrowing costs. A problem arises, however, when rates fall so low that the amount banks can charge their customers in interest is closing in on what they themselves pay for money.

Last quarter, many banks reported sharp declines in net interest margin, or the difference between the interest rate banks charge on loans and their own borrowing costs. And in conference calls with analysts, many bank officials warned that the declines could worsen if the Fed cut rates again.

Just this week,

North Fork Bank


, a New York regional, warned that its lending margin is being squeezed and that second-quarter earnings will fall short of expectations. The bank made that announcement on the eve of the Fed cut.

Bank of America's concession wasn't unexpected. Earlier in the day, RBC Capital Markets bank analyst Gerard Cassidy said: "We would be surprised if the industry is able to 'stick to their guns' by not lowering the prime rate as the Federal Reserve uses moral suasion to encourage a lower prime rate."