WASHINGTON — — With echoes of the Great Depression haunting global financial markets, the U.S. central bank is pulling out all the stops to avert a crisis, including what could be a massive one-time rate cut to restore confidence in the world's largest economy.

The U.S. Federal Reserve Board, which orchestrated and funded a weekend fire sale of the No. 5 Wall Street broker to rival JPMorgan Chase and Co., is poised to take another bold move today to counter a spreading credit crisis with a potentially historic cut of up to a full percentage point in its key lending rate.

“The Fed has made it clear its top priority is to restore order to financial markets,” said Mickey Levy, chief economist at Bank of America.

Another U.S. rate cut creates a bit of a dilemma for Canada. Lower U.S. rates help push down the value of the U.S. dollar, which, in turn, makes Canadian exports less competitive in its main foreign market.

Financial trading and interbank lending almost ground to a halt on Monday as banks grew fearful of dealing with each other following Friday's near collapse of U.S. investment firm Bear Stearns. (AP)

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JP Morgan Chase has agreed to buy rival Bear Stearns, a move that contributed to the Fed announcing a cut in the emergency

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But Bank of Canada Governor Mark Carney has insisted he will set monetary policy based on economic conditions in Canada, not because of panic in global financial markets or external credit problems.

Sophia Drossos, a former Fed economist who is now a currency strategist at Morgan Stanley in New York, said problems that some traders and investors had assumed were specific to the United States now appear to be spreading around the globe.

Canada, because of its close trade and financial ties, could be the first to feel the effects, she said.

“Canada could be first,” Ms. Drossos said. “The case can be made that other economies are going to start to look increasingly shaky and the U.S. may not be alone in this.”

Yesterday, the Big Six banks in Canada began putting existing relationships under a microscope by “stress testing” their exposure to rivals, using sophisticated computer models to run worst-case scenarios on derivative contracts and credit.

Worried that the sudden demise of Bear Stearns may be a harbinger of more financial failures, spooked investors in Canada and elsewhere fled yesterday to the perceived safety of gold and government bonds.

The Standard & Poor's/TSX Composite Index dropped almost 301 points, or 2.3 per cent, to 12,952.15, the lowest since Feb. 7. Royal Bank of Canada and other finance companies led the decline.

U.S. President George W. Bush and other top officials tried to allay growing fears, vowing to do everything in their power to keep the U.S. financial system sound.

“We've taken strong and decisive action,” he said, characterizing the economic environment as “challenging” as he spoke to reporters at the White House.

“We obviously will continue to monitor the situation. And, when need be, we'll act decisively, in a way that continues to bring order to the financial markets.”

Another rate cut today would mark the sixth time in six months that the Fed has lowered it benchmark federal funds rate as it scrambles to avert a recession and keep the banking industry from seizing up. A full percentage-point cut would lower the Fed's key rate to 2 per cent – the lowest level since November of 2004.

The virulence of the continuing credit crunch – marked by banks balking at the common practice of lending to one another – has prompted comparisons to the runs on banks that occurred during the Great Depression of the 1930s.

“Many fear that [Bear Stearns] is the first of several large-scale firms to fail,” John Johnston, chief strategist at RBC Dominion's Harbour Group, said in a note to clients. “In the worst-case scenario, this could turn into something akin to the U.S. experience in the 1930s,” or the fallout from the bursting of Japan's real estate bubble in the late 1980s.

Merrill Lynch economist David Rosenberg doesn't buy the comparison to the Great Depression. But he acknowledged the “situation seems to be turning into a mini-Japan.”

Lehman Brothers Holdings Inc. , Wall Street's fourth-largest broker, has become the latest target of speculators. Investors sent its shares plunging more than 35 per cent yesterday in spite of assurances from chief executive Richard Fuld that liquidity isn't a problem.

In addition to backstopping the Bear Stearns deal with a $30-billion (U.S.) loan, the Fed announced that it would provide funds to any other troubled investment dealers for the first time since the Depression. The Fed traditionally has provided funds to so-called primary dealers – the large commercial banks.

Bear Stearns's market value shrunk to just $240-million – the price at which it agreed to sell out – from more than $3.5-billion as the company's ability to borrow and do business reached a crisis over the weekend. The company was the most exposed of the big Wall Street brokers to high-risk mortgaged-based bonds.

The Fed's aim was to restore liquidity, as well as confidence to the market. But tumbling global stock markets and a retreat to safe havens such as government treasury bills and gold suggest fear continues to drive financial markets.

The Dow Jones Industrial Average, made up of 30 U.S. blue-chip stocks, rebounded from a sharp sell-off yesterday, closing up 21.6 points to 11,972.25. But virtually all other stock markets in Canada and around the world fell sharply.

Gold rose 0.3 per cent to close at a new record of more than $1,000 an ounce

Analysts said inter-bank lending virtually ground to a halt yesterday as financial institutions grew fearful of dealing with one another in the wake of Bear Stearns's precipitous fall.

As banking stock prices and the U.S. dollar plummeted, banks' access to unsecured borrowing from other banks fell to a relative trickle and dealers said the over-the-counter market had become highly discriminatory, depending on the bank name. The free-up in money markets was reflected in the largest single-day rise since the Sept. 11, 2001, terrorist attacks in a key benchmark lending rate – the London inter-bank offered rates.