Stocks: Bernanke Plays Scrooge

Disappointment with the central bank's moves -- especially its quarter-point discount rate easing -- sparked a sell-off Tuesday

Like a child who got a reindeer sweater instead of the Wii he was secretly hoping for, Wall Street sulked after the Federal Reserve unveiled its holiday present Tuesday. Major U.S. stock indexes each tumbled over 2% after the Fed's policy-setting committee lowered the benchmark Fed funds rate target by 25 basis points to 4.25%, as widely expected.

Fed policymakers also cut the discount rate by 25 basis points to 4.75%. Investors were disappointed that the Fed did not make a more aggressive move amid some market speculation the central bank was going to cut the discount rate by as much as 75 basis points.

While the market was largely preoccupied with the Fed, news that troubled mortgage lender Washington Mutual has slashed its dividend by nearly 75% and expects to take some hefty loan loss provisions seemed to stoke some investor anxiety. Meanwhile, Citigroup culminated its month-long search for a new CEO, appointing Vikram Pandit to the post.

On Tuesday, the Dow Jones industrial average fell 294.26 points, or 2.14%, to 13,432.77. The broader S&P 500 index dropped 38.31 points, or 2.53%, to 1,477.65. The tech-heavy Nasdaq composite index lost 66.60 points, or 2.45%, to end at 2,652.35.

Financials, homebuilders, retailers and Real Estate Investment Trusts all sold down at least 5% following the Fed's announcement, as investors expressed their annoyance with the central bank's lack of urgency about current conditions in the financial markets.

On the New York Stock Exchange, 26 stocks traded lower for every five that were on the upswing, while on the Nasdaq the ratio was 23 to six negative, though trading remained sluggish even after the Fed's decision, S&P MarketScope said.

The Fed said growth "is slowing" and that "strains in the financial markets have increased." Policymakers noted that core inflation has improved modestly, but with elevated commodity prices, they still see some inflation pressures.

The FOMC did not give a clear indication on its policy bias, saying their actions along with the prior easings "should help promote moderate growth over time."

The FOMC note concluded by saying the committee "will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth." That leaves the door open for more easing down the road if necessary, says Action Economics.

As was the case with the October 31 rate cut, the FOMC vote was 9-1, with Eric S. Rosengren dissenting in favor of a 50 basis-point cut in the Fed funds rate.

The rate cut is the third such move by the Fed since August, when the subprime crisis began to worsen. A slumping housing sector, and concerns that subprime losses by big banks could tighten credit, have spurred worries about a pronounced slowdown in U.S. economic growth.

The market's disappointment centered on the Fed's failure to close the gap between the Fed funds rate and the discount rate, said Diane Dercher, chief economist at Waddell & Reed in Kansas City. Cutting the discount rate by at least 50 basis points to 4.50% would have helped overcome banks' resistance to borrowing at the discount window and loosened some of the liquidity restraints, and yet the Fed chose not to do that, she said.

The Fed's unwillingness to be more creative in providing a stimulus is all the more perplexing given that "they're recognizing we’re in the midst of a slowing economy and it’s more than just a housing slowdown," she said. "The disconnect here is that the market is anticipating the economy to be a lot weaker than what it appears the Fed believes and [the Fed] doesn't think they need to do as much as the market believes they need to do."