Fed faces crucial week for US banks, economy

18th March 2008, Comments 0 comments

With financial markets in turmoil and speculation that the US economy may have already entered a recession, the US Federal Reserve has been at the centre of it all.

18 March 2008

Washington (dpa) - With financial markets in turmoil and speculation that the US economy may have already entered a recession, the US Federal Reserve has been at the centre of it all.

The current financial crisis "is likely to be judged in retrospect as the most wrenching since the end of the second world war," former Fed chairman Alan Greenspan wrote in Sunday's Financial Times.

On Tuesday, Greenspan's successor Ben Bernanke will again enter the fray as the Fed considers just how strong a cut in its benchmark interest rate is necessary to keep the economy afloat. The current rate stands at 3% - after two successive cuts in January of a combined 1.25 points - and could be dropped to as low as 2% after the board's meeting.

The Fed also cut its separate discount lending rate to banks by 0.25 points to 3.25% during a rare emergency meeting on Sunday, but the rate settings are not what has attracted the attention of most investors.

Of greater significance are the lengths the Fed has gone to rescue investment banks and mortgage lenders on Wall Street that have suffered billions of dollars in writedowns over the past year.

Last week the Fed made available an extra 200 billion dollars in Treasury securities, and took the unusual step of accepting as collateral mortgage-backed securities and other debts that lie at the heart of the current credit crisis.

Days later the central bank made the near-unprecedented move of announcing a bailout of the nation's fifth-largest investment firm, Bear Sterns, by offering it much needed short-term cash through competitor JPMorgan Chase.

The surprise move prompted a massive sell-off in the bank's shares as clients pulled some 17 billion dollars from Bear Stearns in the two days preceding the Fed bailout, according to Bloomberg financial news.

But on Sunday the Fed approved the sale of Bear Stearns to JPMorgan for 240 million dollars - at about one tenth of its share value a week ago - as it became clear the company would otherwise have been forced to file for bankruptcy. In addition the Fed has offered JPMorgan up to 30 billion dollars in financing to take on the firm's debt.

News of Bear Stearns' downfall prompted stock indices to plummet around the world amid fears that other investment banks might be in similarly dire straits.

The true measure will likely come in the next few days.

Goldman Sachs and Lehman Brothers are to report their quarterly earnings Tuesday, and both are expected to post a sharp drop in profits. Morgan Stanley's turn comes a day later.

President George W Bush on Monday defended the Fed's moves, saying they provided a much-needed stabilization of financial markets. Treasury Secretary Henry Paulson suggested a Bear Stearns bankruptcy could have had a much larger spillover effect.

In total, the Fed has opened up about 430 billion dollars in Treasury securities through various loan facilities to banks and mortgage lenders - about 60% of its available assets, according to Bloomberg.

Investment banks themselves have also backed the Fed's attempts to boost liquidity in an effort to ease investors concerns that Bear Stearns may not be the only bank in trouble.

Lehman Brothers Chief Executive Richard S Fuld Jr in a statement Monday said that moves by the Fed last week to open up its securities, "improves the liquidity picture and, from my perspective, takes the liquidity issue for the entire industry off the table."

Meanwhile Democrats are criticizing the Bush administration for failing to address another key issue - the record number of home foreclosures by subprime mortgage-holders that sparked the credit crisis and bank writedowns in the first place.

"Let's not forget about the millions of households with many millions of Americans, with the consequences that that has for the economy, as well," presidential hopeful Hillary Clinton said Monday.

The housing and credit crisis that began over the summer has long since trickled into the rest of the economy. The world's largest economy grew by an annualized 0.6% in the last quarter of 2007 and polls show more than two-thirds of Americans believe the United States has already entered a recession.

Paulson acknowledged the need to address the home foreclosure rates, but said rescuing financial institutions that offer mortgages had to remain a top priority.

"There's the moral hazard on the one hand, and on the other there is the importance of orderly markets, stability in our financial system," he told reporters after a meeting with Bush and his economic advisors.

The Bear Stearns rescue "was an easy decision. This has the right outcome," he said.

[Copyright dpa 2008]

0 Comments To This Article