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Friday, August 17, 2007

The Federal Reserve Acts to Stabilize Credit Markets 

We've now posted twice on the subject of our deteriorating credit market, first on July 25th, then on August 1st.

This morning, the Fed took a reasonably unusual action. It reduced the rate it charges financial institutions from 6.25% to 5.75%. This is not the oft-noted Fed Funds rate, which stands at 5.25% and has been raised relentlessly to reduce the money supply, choke off inflation, end the housing bubble and slow growth. The Fed chose instead to reduce the discount rate, and communicate to the markets that it is prepared to act as a lender of last resort, at below market rates, against collateral which the markets currently shun and against which they would not lend. It has stepped in to provide liquidity when, say, the commerical paper market might not.

The Fed woke up last week, in particular as 2 financial institutions of note began to struggle with liquidity and funding themselves. We noted Bear Stears already in the August 1st post -- however, to that management's credit, Bear Stearns had reduced its reliance on short term funding markets as early as January.

Countrywide Credit -- about which we've not written, but which stands in the midst of the stricken mortgage financing market -- this week drew down $11 billion of cash from available short term lines provided by about 40 banks. This qualifies as a 5 alarm warning. CFC stock has fallen from a $45 high this year, to less than $20 per share this week. Analysts began to shout "fire" in a panicked capital market.

And the Fed just told the markets -- I suppose shorts in particular -- that it will not allow a major financial institution to fall over for lack of an ability to fund its assets, or alternatively force the sale of those assets at distressed prices.

The Fed has just executed a nicely calibrated maneuver intended to install confidence in our lending institutions while electing not to bail out those hedge funds who may have taken excessive and imprudent risk. They will continue to have to sell assets to meet August 15th redemption notices for September 30th -- runs on their "bank" as it were. It has thus protected the markets from an even greater avalanche of assets -- mortgage assets in this case -- hitting the market and driving down prices from banks who have access to t he Fed discount window.

As a result, the shares of financials rallied today in general after staging a late and very strong rally yesterday. In addition, the Treasury yield curve (so called because it graphically depicts the term structure of interest rates across a range of maturities; x-axis is in years, y-axis is in interest rates) has finally begun to assume a positive slope. This means that interest rates are lower for shorter maturities and higher for longer maturities. A positively shaped yield curve typically signals that investors believe the economy will resume more rapid expansion, while a negatively sloped curve signals an economic slowdown approaching.

All that means is that I'm getting optimistic. The Fed is on the case. Bond market participants are beginning to see the light at the end of the tunnel. As the summer turns to fall, risk taking should resume, our credit markets should operate sensibly if at higher cost and our economy should continue to hum. All other things being equal, of course.

Enjoy the balance of the summer. And TH, I think if you let the facial hair go for a few days, you're going to look like Alec Baldwin:)

5 Comments:

By Blogger Christopher Chambers, at Fri Aug 17, 04:17:00 PM:

Whew!!! I was thinking about those greedy bankers, hedge fund managers and smarmy private equity tools and boy I am so happy they're off the hook. I mean, liberal Hollywood needs to stop doing bleeding heart movies (like the Constant Gardener) and show the tribulations of these other folks. Lord have mercy I am so happy what the Fed did. I cried. I really cried that all will be well for these people, our wonderful system. God bless Ben Bernanke. I have to go hug some children now... LOL  

By Blogger Georg Felis, at Fri Aug 17, 04:33:00 PM:

It is good to see the Fed making sensible decisions such as these. Makes me feel more comfortable with Greenspan’s replacement. Still there are an awfully lot of bad companies out there who have gotten their companies so overextended that they are going to pop, and the resulting Dow wiggles will give great pleasure to many BDS CC’s of the world, as well as sharp business types who pick up the profitable pieces. The bad side is that these failed business types tend to become authors…  

By Blogger Cardinalpark, at Sat Aug 18, 03:35:00 PM:

CC - your need to constantly make plain your ignorance is a terrible shame. If you understood something about economics, you would soon realize in fact that the very wealthy are fine with or without Mr. Bernanke's very intelligent maneuver (which I still doubt you understand), but most working folks would be worse off in a recession.

Fool. You and Michael Moore should spend more time in your vision of Utopia - Cuba. Asta luego chico.  

By Blogger Jason Pappas, at Sun Aug 19, 07:52:00 AM:

I predict that it won’t be over until a scapegoat is skinned and hung to dry to appease the mob.  

By Blogger Unknown, at Sun Aug 19, 10:39:00 AM:

While I can see moving the optimism meter from depressed to unsettled, I wouldn't go all the way over to optimism just yet.

Mostly, we need to see the credit markets get a bit more liquid, for solid credits anyway, before that happens. I'd like it best if the Fed would articulate a plan, firstly, so the market can evaluate whats upcoming. Transparency is better than mystery, wouldn't Bernanke say?  

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