NEW YORK—Despite the criticism surrounding U.S. Federal Reserve Chairman Ben Bernanke, you can't fault him for not trying. Early this week, the Fed made sweeping changes to how the central bank lends money to financial institutions in an effort to stem a worsening financial crisis that threatens to throw the United States into a deep recession.
For the first time in history, the Fed will allow securities firms to borrow from the Fed at the same discount rate as commercial banks. On the same day, the Fed also lowered such discount rates from 3.50 percent to 3.25 percent, and extended the maximum borrowing window from 30 days to 90 days.
The announcement came on the heels of the Fed agreeing to lend roughly $30 billion to help JPMorgan Chase & Co. complete its buyout of troubled investment bank Bear Stearns Cos. According to the Fed, the $30 billion loan is guaranteed solely by Bear's highly risky assets on its balance sheet, and any loss in value would be shouldered by the central bank.
The move signals how concerned the Fed is about the health of the U.S. economy and ramifications of a deep recession on the global economy. Bear, once one of the most respected securities firms on Wall Street, was sold to JPMorgan for a mere pittance at $2 a share. The company's stock once topped more than $170 per share in early 2007.
Desperate Measures
Recent events also confirmed the worst predictions from a year ago. Subprime loan defaults among consumers led to heavy losses at financial institutions, which triggered a widespread credit tightening as lenders around the world became concerned about the ability of companies repaying their loans. As the credit crunch worsened, companies pulled back their investments in risky markets and began hoarding cash, further tightening liquidity at financial institutions.
Last week, the Fed announced $200 billion in credit to allow banks to borrow Treasury securities using their mortgage-backed securities as collateral. Tomorrow, the Fed may slash interest rates by another three-quarters of a percentage point. But ultimately, the moves may do little to calm investors' fears.
"It doesn't address the fundamental problems, which is that financial markets are just scared," David Wyss, Standard & Poor (S&P)'s chief economist, told CNN. "The Fed is trying, but they don't have a magic wand to wave and make everyone confident again."
The collapse of Bear shook the financial markets globally, as investors fretted about the fortunes of other banks.
The task at hand is to prevent another bank from going down. Bear was the smallest of the so-called "bulge-bracket" Wall Street investment banks, but it was a major player in the mortgage-backed securities market. Shares of Lehman Brothers Holdings, Inc. and UBS AG fell sharply on Monday as confidence in the banking industry continues to erode.
Is the End in Sight?
The old adage "diversify your portfolio" rings especially true during times of financial turmoil. Diversified firms such as Citigroup, Inc. and JPMorgan Chase are better suited to weather the credit storm as they have stable cash-generating business in their commercial and consumer banking units.
Some analysts believe that while major banking institutions have disclosed most of their losses, negative investor confidence and other market forces may put additional pressure on earnings.
"The positive news is that, in our opinion, the global financial sector appears to have already disclosed the majority of valuation write-downs of subprime ABS," said S&P credit analyst Scott Bugie, in a media release.
"But right now, market forces are placing further downward pressure on valuations, and we expect to see more write-downs related to these pressures in coming weeks and months," Bugie concluded.
With recent measures, the Fed has shown a willingness to respond to market realities. Now, it may be up to the corporations, investors and financial institutions to restore confidence in our financial markets.
Feeds