Monday, March 17, 2008 4:44:08 AM
U.S. Fed wades further into risky waters
Chairman of the U.S. Federal Reserve Ben Bernanke speaks at the National Community Reinvestment Coalition luncheon in Washington March 14, 2008.
REUTERS/Kevin Lamarque
By Emily Kaiser and Ros Krasny - Analysis
Mon Mar 17, 2008 3:38am EDT
WASHINGTON/CHICAGO (Reuters) - The U.S. Federal Reserve is taking a risk by opening up its own balance sheet to the same poisonous securities that have strained banks to the limit. But the risk of doing nothing is far greater.
The central bank seems to be wading further into shark-infested waters by the day as it looks to shore up a blighted credit market that threatens to prolong the pain for a U.S. economy that many analysts fear is already in recession.
The Fed had little choice but to act after investment bank Bear Stearns became the biggest casualty to date of the seven-month-long credit crisis, analysts said.
The firm agreed to a $2 per (0.98 pence) share buyout from JPMorgan Chase & Co on Sunday. Its shares had traded around $60 on Thursday and $160 (78.9 pounds) last April.
In a surprise move, also on Sunday, the central bank made an emergency quarter-percentage point cut it its discount rate that it charges on loans to banks, and announced a central role in the Bear Stearns deal. The discount rate was dropped to 3.25 percent.
Analysts said risks to the U.S. financial system approaching those seen during the Great Depression forced the Fed's hand.
"The U.S. financial system probably is under more strain now than for at least several decades. Let's hope (the Fed's) determined efforts eventually get 'traction,'" said Rory Robertson, analyst at Macquarie Bank in Sydney.
The last time the Fed lowered rates in an emergency move, in January, it was at the beginning of the New York business day and came in the form of an unexpected three-quarter point cut in the benchmark federal funds rate.
With the crisis now accelerating, policy-makers, who hold a regularly scheduled policy meeting on Tuesday, clearly felt they could not wait.
While the intent was to keep financial markets functioning, the side effect is increased exposure to the mortgage-backed securities that have left gaping holes in banks' balance sheets and constrained lending to the companies and consumers that propel the U.S. economy.
"Ideally they're trying to minimize the risk but even risks that are prudently minimized are still risks," said Michael Feroli, U.S. economist with JPMorgan in New York.
"As with discount-window lending, there's always the possibility that the institution fails and the collateral is worth less than you hoped, and then you take a loss."
PRECARIOUS BALANCE
The Fed's balance sheet lists assets of $869 billion, of which $709 billion are Treasury securities held outright.
Feroli said the Fed was unlikely to need more cash because its so-called discount window, where it lends directly to banks, has built-in layers of protection.
First, the central bank lends only to primary dealers, the big names in the financial world. That means the risk of an outright failure is minimal -- although Bear Stearns' swift demise serves as a reminder that it is not unheard of.
Second, the Fed assigns a "haircut" or markdown to securities pledged as collateral, which means they would have to shed significant value before the Fed felt the loss.
"Ultimately if there is a credit risk it gets borne by the taxpayers because the surplus returned to Treasury would be lower," Feroli said. "In a roundabout way the taxpayer has to bear that."
Jack Ablin, chief investment strategist at Harris Private Bank in Chicago, said the Fed had to step in to provide a bridge between the current turmoil, where banks are unable to value assets, and hopefully calmer times ahead.
"If it believes that there's value at the end of the road, what it's got to do is provide liquidity to get from here to there," he said. "If this is really a pile of worthless securities, then the Fed is in a lot of trouble."
MARKETS UNCONVINCED
Financial market's saw Sunday's surprise move as a prelude to a bigger-than-previously expected cut in the federal funds rate when policy-makers hold a regularly scheduled meeting on Tuesday.
Interest rate derivatives implied a full-point move to 2 percent was the base case, and pointed to a federal funds rate of 1.5 percent or lower by mid-year.
"The (Fed's) decision might boil down to a judgment about whether a bigger move would be helpful, given the suggestion of 'panic' it might carry," said Robertson.
U.S. stock index futures, which point to where cash equities markets are expected to open on Monday, plunged in the wake of the Fed's announcement.
Rather than see the Fed's move on Bear Stearns and the discount rate as an end, markets fear Sunday's surprise announcement may be just the beginning.
"The threat of contagion and wholesale breakdown on a scale of 1929 is real," said Peter Morici, economics professor at the University of Maryland.
(Editing by Neil Fullick)
© Reuters 2008 (emphasis added)
http://www.reuters.com/article/newsOne/idUKN1651144220080317 [ http://www.reuters.com/article/newsOne/idUKN1651144220080317?sp=true ]
Chairman of the U.S. Federal Reserve Ben Bernanke speaks at the National Community Reinvestment Coalition luncheon in Washington March 14, 2008.
REUTERS/Kevin Lamarque
By Emily Kaiser and Ros Krasny - Analysis
Mon Mar 17, 2008 3:38am EDT
WASHINGTON/CHICAGO (Reuters) - The U.S. Federal Reserve is taking a risk by opening up its own balance sheet to the same poisonous securities that have strained banks to the limit. But the risk of doing nothing is far greater.
The central bank seems to be wading further into shark-infested waters by the day as it looks to shore up a blighted credit market that threatens to prolong the pain for a U.S. economy that many analysts fear is already in recession.
The Fed had little choice but to act after investment bank Bear Stearns became the biggest casualty to date of the seven-month-long credit crisis, analysts said.
The firm agreed to a $2 per (0.98 pence) share buyout from JPMorgan Chase & Co on Sunday. Its shares had traded around $60 on Thursday and $160 (78.9 pounds) last April.
In a surprise move, also on Sunday, the central bank made an emergency quarter-percentage point cut it its discount rate that it charges on loans to banks, and announced a central role in the Bear Stearns deal. The discount rate was dropped to 3.25 percent.
Analysts said risks to the U.S. financial system approaching those seen during the Great Depression forced the Fed's hand.
"The U.S. financial system probably is under more strain now than for at least several decades. Let's hope (the Fed's) determined efforts eventually get 'traction,'" said Rory Robertson, analyst at Macquarie Bank in Sydney.
The last time the Fed lowered rates in an emergency move, in January, it was at the beginning of the New York business day and came in the form of an unexpected three-quarter point cut in the benchmark federal funds rate.
With the crisis now accelerating, policy-makers, who hold a regularly scheduled policy meeting on Tuesday, clearly felt they could not wait.
While the intent was to keep financial markets functioning, the side effect is increased exposure to the mortgage-backed securities that have left gaping holes in banks' balance sheets and constrained lending to the companies and consumers that propel the U.S. economy.
"Ideally they're trying to minimize the risk but even risks that are prudently minimized are still risks," said Michael Feroli, U.S. economist with JPMorgan in New York.
"As with discount-window lending, there's always the possibility that the institution fails and the collateral is worth less than you hoped, and then you take a loss."
PRECARIOUS BALANCE
The Fed's balance sheet lists assets of $869 billion, of which $709 billion are Treasury securities held outright.
Feroli said the Fed was unlikely to need more cash because its so-called discount window, where it lends directly to banks, has built-in layers of protection.
First, the central bank lends only to primary dealers, the big names in the financial world. That means the risk of an outright failure is minimal -- although Bear Stearns' swift demise serves as a reminder that it is not unheard of.
Second, the Fed assigns a "haircut" or markdown to securities pledged as collateral, which means they would have to shed significant value before the Fed felt the loss.
"Ultimately if there is a credit risk it gets borne by the taxpayers because the surplus returned to Treasury would be lower," Feroli said. "In a roundabout way the taxpayer has to bear that."
Jack Ablin, chief investment strategist at Harris Private Bank in Chicago, said the Fed had to step in to provide a bridge between the current turmoil, where banks are unable to value assets, and hopefully calmer times ahead.
"If it believes that there's value at the end of the road, what it's got to do is provide liquidity to get from here to there," he said. "If this is really a pile of worthless securities, then the Fed is in a lot of trouble."
MARKETS UNCONVINCED
Financial market's saw Sunday's surprise move as a prelude to a bigger-than-previously expected cut in the federal funds rate when policy-makers hold a regularly scheduled meeting on Tuesday.
Interest rate derivatives implied a full-point move to 2 percent was the base case, and pointed to a federal funds rate of 1.5 percent or lower by mid-year.
"The (Fed's) decision might boil down to a judgment about whether a bigger move would be helpful, given the suggestion of 'panic' it might carry," said Robertson.
U.S. stock index futures, which point to where cash equities markets are expected to open on Monday, plunged in the wake of the Fed's announcement.
Rather than see the Fed's move on Bear Stearns and the discount rate as an end, markets fear Sunday's surprise announcement may be just the beginning.
"The threat of contagion and wholesale breakdown on a scale of 1929 is real," said Peter Morici, economics professor at the University of Maryland.
(Editing by Neil Fullick)
© Reuters 2008 (emphasis added)
http://www.reuters.com/article/newsOne/idUKN1651144220080317 [ http://www.reuters.com/article/newsOne/idUKN1651144220080317?sp=true ]
Greensburg, KS - 5/4/07
"Eternal vigilance is the price of Liberty."
from John Philpot Curran, Speech
upon the Right of Election, 1790
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