Stocks Sink to Session Lows

Updated from 1:08 p.m. EDT

Stocks extended their losses Tuesday afternoon as Federal Reserve Chairman Ben Bernanke pointed to increased downside risk for the U.S. economy and hinted that his agency may reduce its target interest rate.

The Dow Jones Industrial Average was recently down 336 points to 9620, and the S&P 500 was losing 38 points to 1019. The Nasdaq lost 70 points to 1792.

Addressing the National Association for Business Economics in Washington, D.C., Bernanke said that the outlook for inflation has for the moment improved while growth potential has diminished, and said the bank would need to reconsider its current policy, a hint that his agency may soon cut its target interest rate.

Earlier, the Fed announced creation of a new lending facility to buy short-term commercial paper from businesses and said it expects the new lending program to remove the stoppage in the credit markets.

The Fed's decision to begin buying commercial paper is "a radical change in the nature of the Fed," said Dirk Van Dijk, director of research at Zacks Equity Research. He said that the Fed is now essentially making unsecured loans to corporations. "The commercial paper market was the most constipated of all the financial markets," said Van Dijk. Getting commercial paper moving makes some sense, he said, although the actual impact of the Fed's move remains to be seen.

"Under all this, the real economy is headed south in a very big way. That is in itself going to put a lot more pressure on these banks," said Van Dijk. He said he foresees 200,000 to 250,000 jobs lost in October, a worse loss than the discouraging 159,000 decline in September payrolls. "It's going to be quite bad."

Dysfunctional credit markets were also prompting speculation that the Fed and other central banks would coordinate rate cuts to jump-start lending.

"I think at this point it's needed," said Van Dijk. "Actually, if you look at the effective fed funds, it's trading well below the target rate," he said. A reduction in the U.S. target interest rate, therefore, would be a recognition of reality rather than a policy shift, he said.

"Interbank overnight cash rates are spread so far above central bank rates that any interest rate cut will only deliver psychological icing rather than substantial cake," wrote Carl Weinberg, chief economist at High Frequency Economics, in an email. However, Weinberg said that credit-market psychology was repaired somewhat by coordinated interest-rate cuts in October 1987, October 1998 and September 2001. He said he's looking out for coordinated rate cuts in the very near future.

After the close Monday, Bank of America ( BAC) announced it would cut its dividend and raise $10 billion in fresh capital as it reported quarterly earnings ahead of schedule.

Meanwhile, Citigroup ( C) and Wells Fargo ( WFC) agreed to take a two-day breather from their legal fight over who would get to acquire Wachovia ( WB).

In the technology sector, chipmaker Advanced Micro Devices ( AMD) announced a plan to spin off its manufacturing operations.

Automaker Adam Opel, a segment of General Motors ( GM), said it would cease production at its Eisenach, Germany plant, according to the AP.

As for economic data, traders will get a look at minutes from the Federal Open Market Committee's Sept. 16 meeting, when it elected to leave its key interest rate unchanged at 2%. Later in the afternoon, the Fed's look at U.S. consumer credit is due for release.

In commodities, crude oil was gaining $1.10 to $89.91 a barrel. Gold was gaining $5.50 to $887.50 an ounce.

Longer-dated U.S. Treasury securities were slightly lower. The 10-year was down 4/32 to yield 3.47%, and the 30-year was slipping 8/32 to yield 3.99%. The dollar was edging higher vs. the yen, but softening against the euro and pound.

Abroad, European markets were mixed. Asian exchanges finished mixed following a rate cut from Australia's central bank.

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