"And even as nerve endings remained frayed, there were a few notable signs of improvement on Wall Street, Mr. Rombach and other specialists noted. Particularly encouraging was the sharp narrowing of the spread between ultra-safe Treasuries and bonds backed by Fannie Mae, the government-chartered buyer of mortgages — a sign that investors are willing to consider riskier investments.
If that move toward a more normal assessment of risk persists, it could help drive down interest rates on home loans in the coming days.
The broad Standard & Poor’s 500-stock index, meanwhile, closed down less than 1 percent, recovering much of its losses from early in the day and bucking a strong downdraft from Europe and Asia.
Specialists say their biggest worry now is not whether the economy is already or will soon be in a recession. Far more fundamental and troubling is the health of the financial system that greases the wheels of capitalism.
“Recessions come and go — that is something investors can deal with,” said Marc D. Stern, chief investment officer at Bessemer Trust, an investment firm in New York. “The bigger issue is, Can our financial system be restored to a sense of normalcy? In recent weeks we have been moving away from that, which is potentially very serious.”
Mr. Stern said he was encouraged by the Fed’s response to the problems at Bear Stearns. In addition to facilitating the firm’s sale to JPMorgan, the central bank also started directly lending to securities firms, something it has not done since the Depression of the 1930s.
The policy-making committee of the Fed is expected to cut its benchmark short-term interest rate at a scheduled meeting on Tuesday by as much as one percentage point, from the current 3 percent, making it cheaper for banks to borrow from each other.
Since last summer, the Fed has tried many approaches to ease the strain in the credit markets. It has cut its benchmark rate from 5.25 percent in a series of jagged steps. It has aggressively lent money to banks and accepted lower-quality collateral that might not even be tradable in the market.
Despite those efforts, financial conditions have worsened. And specialists say the latest measures might meet the same fate if banks and securities firms do not put to work the new money the Fed is offering to lend to them.
“The Fed can do no good at all if they effectively print money and give it to the banks, and the banks dig a hole in the ground and put it in there,” said Donald Brownstein, president of Structured Portfolio Management, a hedge fund in Stamford, Conn., that specializes in mortgage securities.
Other investors are worried that the Fed’s extensive intervention will put the central bank at risk of significant losses and that it will create a “moral hazard” by bailing out institutions that should be allowed to fail. And some complain that the Fed’s backing for a $30 billion loan to Bear Stearns by JPMorgan shifts all the risk to Washington while keeping the profits on Wall Street.
“The government is taking all the downside and none of the upside,” said Douglas A. Dachille, chief executive of First Principles Capital, a bond trading firm.
On Wall Street, however, the Fed’s moves, especially its decision to lend directly to 20 securities dealers, were welcomed.
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