Financial markets asking: Where’s the bottom?

Stunning collapse of Bear Stearns hasn’t calmed fears of more bad news

Financial market crises often end with a final, cataclysmic event — a rush of panic selling of stocks or a sudden drop in a currency's value. With the stunning collapse of Bear Stearns over the weekend, many investors are asking themselves: Is this the final upheaval in the earthquake that has been building since the capital markets first started shuddering last August?

The answer, and a major reason for the turmoil in the first place, is that no one — not even Fed or Treasury officials — has any idea.

Until Bear Stearns began to unravel Friday, the financial market had been focused on the Fed’s regular interest rate-setting meeting Tuesday. Most expected the central bank to cut the short-term rates again; opinion was divided between a half or three-quarters of a percentage point.

But after Wall Street began shunning Bear Stearns last week — calling in loans and cutting off future credit — the Fed responded by engineering a takeover of the troubled firm, averting the wider damage of widespread defaults.

“What we're in here is the closest thing we've seen to a bank panic since the Depression,” said Senate Banking Committee Chairman Charles Schumer, D-N.Y. “It's with investment banks, it's with larger investors. But it's the exact same thing. Confidence is so important. The quality of the asset matters less than confidence, and hopefully this move will restore confidence when it comes to some of these other firms."

For added measure, the Fed cut one key rate by a quarter-point Sunday and agreed to make loans through its "discount window" to investment banks as well as commercial banks.

Now forecasters have all but thrown up their hands trying to predict what the Fed will do on Tuesday. Given the tumultuous environment, many expect the central bank to slash the benchmark overnight lending rate by a full percentage point, to 2 percent, less than half the 5.25 percent level when the Fed began cutting rates last June. 

Some investors worry that the Fed’s aggressive efforts to pump tens of billions of dollars into the financial system comes with a hefty price — higher inflation and a weaker dollar.

“Our dollar has been killed,” said Brian Wesbury, chief economist at First Trust Advisors. "The price of gold has gone from $700 to $1,000. The price of oil has gone from $70 to $110. This inflationary pressure that the Fed has caused is making mayhem in the financial markets."

To make matters worse, the turmoil shaking the global credit markets is not about the cost of money. Banks have cash, and if they need more they can borrow it cheaply from the Fed. The problem is that, after watching assets backed by mortgages melt away, banks are afraid to lend.

Some observers see the dramatic collapse of Bear Stearns as a sign that the worst may be over.

“Once the fear is alleviated, liquidity will come back into the markets,” said Richard Bove, a banking industry analyst at Punk Ziegel and Co. “I think we'll find this out in the next four or five days. It's not going to last two, three, four, six months.”

But other observers say it could take longer. The reason is that much of the distressed debt at the source of the credit meltdown is held outside of the view of regulators and investors in the global credit market — the banks, investment firms, pension funds, insurance companies and others who swap trillions of dollars worth of debt every day.

What’s got them all spooked is a relatively new form of debt securities based on highly complex transactions used to offset the risk of borrowing. Those pieces of paper turn out to be difficult to price under the best of circumstances.

Though they’ve been battered by losses related to the housing recession and mortgages gone bad, banks are still in relatively good shape — so far. Loan delinquencies are at about half the levels seen at the peak of the last big credit crunch in 1991, according to a recent research report by Morgan Keegan.

But those delinquencies are rising. With home prices falling, and billions of dollars of paper backed by mortgages at risk of default, the biggest unknown is tied to the million of loans scheduled to reset to higher rates that many homeowners will be unable to keep up with. So until the housing market shows some signs of stabilizing, it’s all but impossible to know how much more money will be lost from mortgage defaults.

“We won't even know what happens until they reset, first of all, later this year and in '09 or '10 — or even go to their 30-year length," said Wesbury. "The financial markets are pricing in all of these (defaults) for the next, two, three, five, 20 years right now. So, have we priced it all in or not?”

Fed officials are hoping to overcome the breakdown in confidence by making money cheap —and offering to lend to whoever need its.  In guaranteeing the credit line that JPMorgan used to back Bear Stearns obligations, the Fed crossed a line that has historically walled off the tightly regulated banking industry from the far more risky securities business.

Some Fed watchers say that targeting loans directly to the source of the problem helps get to a solution more quickly.

“If you look back 20 years or so, what the Fed would do is call up the commercial banks and say, ‘Now, be sure to lend money to all the investment banks,’” said former Fed Gov. Robert Heller. “And rather than doing it indirectly through the banks, which creates another problem because they take assets on to their own balance sheets, the Fed is short-circuiting the process and giving liquidity directly where it's needed the most.”

The worry is that the move may encourage investment firms to make riskier bets in the future — knowing that the Fed is ready to back up those bad bets to avoid wider financial calamity. But Heller says the process of rescuing Bear Stearns has already been painful enough to discourage such future bed bets.

“You cannot talk about a bailout of Bear Stearns,” he said.  “If you're a shareholder of Bear Stearns, you would have lost it all. You're walking away with 1 percent of your asset value.”

URL: http://www.msnbc.msn.com/id/23676448/

Federal Reserve System

From Wikipedia, the free encyclopedia

The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. Created in 1913 by the enactment of the Federal Reserve Act, it is a quasi-public (part private, part government) banking system^[1] composed of (1) the presidentially-appointed Board of Governors of the Federal Reserve System in Washington, D.C.; (2) the Federal Open Market Committee; (3) 12 regional Federal Reserve Banks located in major cities throughout the nation acting as fiscal agents for the U.S. Treasury, each with its own nine-member board of directors; (4) numerous private U.S. member banks, which subscribe to required amounts of non-transferable stock in their regional Federal Reserve Banks; and (5) various advisory councils. Currently, Ben Bernanke serves as the Chairman of the Board of Governors of the Federal Reserve System.

Bank runs occur because banking systems are usually fractional reserve lending institutions and do not have enough cash in reserves to give to all of their depositors simultaneously. Bank runs can lead to a multitude of social and economic problems. The Federal Reserve was designed as an attempt to prevent this from occurring.

How the Federal Reserve addresses the problem of bank panics is described in The Federal Reserve System - Purposes and Functions:^[14]

[edit] Lender of last resort

The Federal Reserve has the authority and financial resources to act as “lender of last resort” by extending credit to depository institutions or to other entities in unusual circumstances involving a national or regional emergency, where failure to obtain credit would have a severe adverse impact on the economy.^[15]

Through its discount and credit operations, Reserve Banks provide liquidity to banks to meet short-term needs stemming from seasonal fluctuations in deposits or unexpected withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The rate the Fed charges banks for these loans is the discount rate (officially the primary credit rate).

In making these loans, the Fed serves as a buffer against unexpected day-to-day fluctuations in reserve demand and supply. This contributes to the effective functioning of the banking system, alleviates pressure in the reserves market and reduces the extent of unexpected movements in the interest rates.^[16]

[edit] Central bank

In its role as the central bank of the United States, the Fed serves as a banker's bank and as the government's bank. As the banker's bank, it helps to assure the safety and efficiency of the payments system. As the government's bank, or fiscal agent, the Fed processes a variety of financial transactions involving trillions of dollars. Just as an individual might keep an account at a bank, the U.S. Treasury keeps a checking account with the Federal Reserve through which incoming federal tax deposits and outgoing government payments are handled. As part of this service relationship, the Fed sells and redeems U.S. government securities such as savings bonds and Treasury bills, notes and bonds. It also issues the nation's coin and paper currency. The U.S. Treasury, through its Bureau of the Mint and Bureau of Engraving and Printing, actually produces the nation's cash supply; the Fed Banks then distribute it to financial institutions.^[17]

The Federal Reserve implements monetary policy by influencing the interbank lending of excess reserves. Interbank lending occurs when too many withdrawals have been made at a bank and it needs to borrow funds from another bank to make up the difference. The rate that banks charge each other for these loans is determined by the markets but the Federal Reserve influences this rate through the three tools of monetary policy which are described in the "Tools of monetary policy" section below. A summary of the basis and implementation of monetary policy is stated by the Federal Reserve:

"The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks...By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility, the Federal Reserve exercises considerable control over the demand for and supply of Federal Reserve balances and the federal funds rate. Through its control of the federal funds rate, the Federal Reserve is able to foster financial and monetary conditions consistent with its monetary policy objectives."^[14]

This influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth.^[36]

 Loans and investments, particularly in a global economy, are very complex. All the implications of what is happening in the bail out of the large investment bank, Bear Stearns, by the Federal Reserves Banks is probably "over the head" of many of the working class. Unfortunately, "s*#t runs down hill". What Big Business does or doesn't do ultimately affects the working class. The working class needs Big Business to have the necessary cash flow to invest, make pay rolls, borrow and lend. In my opinion, the Federal Reserve Banks provide necessary security for banks and governments so that America doesn't have another Great Depression. The fact that these banks charge interest for the monies loaned or created is just "business as usual". I don't see the Federal Reserve Banks as some sort of dark world controlling "Illuminati". To me the Federal Reserve Banks are just banks helping other banks from crashing. We all need someplace to cash our checks!

tags: the fed  federal reserve banks  bear stearns  banking  investments  loans  mortgages  sub prime mortgages  capitalism  free enterprise  disaster capitalism  economy  power  

links: digg this    del.icio.us    technorati    reddit