WASHINGTON — The Federal Reserve, seeking to prevent Monday's stock market crash from causing a wave of bank failures similar to those that followed the 1929 collapse, pledged Tuesday to take whatever steps are needed to protect the nation's financial system.
Underscoring its determination, the Fed injected funds into the banking system before noon in a move traders said both helped encourage a decline in interest rates and helped assure financial institutions that they would have the means to meet their obligations.
"The Federal Reserve, consistent with its responsibilities as the nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system," Fed Chairman Alan S. Greenspan said in a one-sentence statement issued shortly before the stock market opened.
Greenspan canceled a long-scheduled speech in Dallas to the American Bankers Assn. convention, returning to Washington "to monitor developments in the financial markets." And Treasury Secretary James A. Baker III cut short a trip to Europe and met with Greenspan and President Reagan at the White House.
Reagan, bowing to pleas from lawmakers, announced that the Administration would accept a "budget summit" with congressional leaders from both parties to discuss a deficit reduction package aimed at avoiding $23 billion in automatic spending cuts next month.
Speaking to reporters outside the White House after meeting with the government's top two economic officials, Reagan also said that he is "pleased that the steps taken by the Federal Reserve have had a salutary effect on the markets." And Reagan said he is encouraged that "the bond market is strong and the foreign exchange markets are stable."
Interest rates fell across the board Tuesday as investors poured funds into government securities in an effort to find a safe haven for their money. The fears of rising interest rates and higher inflation that had helped trigger the market collapse appeared to evaporate in the wake of reassuring statements from the Fed and central bankers in West Germany and Japan.
"It's an easing of credit worldwide," said Michael Snow, an economist for Union Bank of Switzerland in New York. "There's going to be a flood of money."
In contrast to 1929, when the Fed actually tightened credit conditions, Greenspan's statement made it clear that the central bank is prepared to serve as a lender of last resort to any financial institution that gets in trouble.
"The banking system collapsed between 1929 and 1933 because the Fed thought it had to shrink the money supply," said Stephen Axilrod, vice chairman of Nikko Securities in New York and the former chief monetary policy staff member at the Fed. "They are not going to make that mistake."
At the annual bankers' convention in Dallas, officials stressed that there are no signs of the run on deposits at financial institutions that followed the 1929 collapse.
"There should be no concern over the safety of . . . deposits," said Robert L. Clarke, U.S. comptroller of the currency. "I think the banking industry is in general very safe."
Unlike 1929, Clarke noted, deposit insurance today covers bank accounts of up to $100,000. And because of laws approved in the 1930s during Franklin D. Roosevelt's New Deal, "banks do not invest in equity securities," Clarke said. The stock market crash "should not affect investment portfolios of banks."
L. William Seidman, chairman of the Federal Deposit Insurance Corp., added that his agency was closely monitoring the banking system and found no immediate danger of massive deposit withdrawals.
"There also have been no problems with banks' assets," Seidman told reporters at the convention.
The Fed, in moving to reassure shell-shocked investors that it would supply credit as needed, helped drive the key federal funds rate as low as 6.75% Tuesday. By buying government securities from banks in the open market, the Fed is able to provide banks with injections of cash. That helped to sharply lower the rate banks charge each other on overnight loans from the 7.61% rate on Monday and the 7.5% it averaged earlier this month.
As interest rates plunged, the value of existing Treasury bonds soared, pushed higher as well by the stronger dollar, which rose in response to signs of reconciliation between the United States and West Germany over monetary policy.
In Bonn, West German Finance Minister Gerhard Stoltenberg said his meeting on Monday with Baker demonstrated that the United States and Germany remained determined to stabilize exchange rates, while Germany's central bank halted the recent rise in interest rates there by offering funds at a fixed rate of 3.8%. There were also indications that the Bank of Japan would relax its policy to help assure panicky investors in Tokyo.