The moves by the US Federal Reserve to drive the bailout and sale of failed investment bank, Bear Stearns; cut its market dealing rate by 0.25% and establish a line of credit for US financial markets, represents the most significant moves by the central bank to try and steady jittery markets in over 60 years.
Nothing since the Depression has been so dramatic: fevered work across a weekend culminating in a deadline of 10 am Monday, Tokyo time, when the stockmarket was to open (the Fed ignored Australia!).
Talks with other regulators, the Bush Administration, with representatives of JP Morgan and Bear Stearns, lawyers and others from the markets meant for late night sessions lasting until early Monday morning.
And to make the point about the importance of it all, Fed Chairman, Ben Bernanke conducted a late evening conference call with reporters to not only brief them on what went on, but flesh out the context.
This was backed up by other briefings from Fed officials to media in Washington and New York, especially wire services like Reuters, Dow Jones and Bloomberg
The story was simple: in a series of emergency decisions aimed at containing a crisis of confidence in the US financial system, the Fed cut its discount rate 0.25% to 3.25% and opened up borrowing at the rate to securities firms, including non banks, the most important disseminators of credit and liquidity in the US markets.
This facility will remain in place for at least six months. The Fed also extended the maximum term of loans to commercial banks to 90 days from 30 days.
Included in the deals was a $US30 billion line of credit to help JPMorgan Chase to buy Bear Stearns for a derisory $2 a share in Morgan shares. (The loss for Bear Stearns shareholders was a massive 97 %.) Bear Stearns was crippled by a run on it last week (just as Northern Rock was forced into the hands of the UK government by the run last August). The line of credit will help finance the hard to sell parts of Bear Stearns’ assets portfolio.
Unlike Northern Rock, the run on bear Stearns threatened the stability of global markets.
The deal had to be done by the time Tokyo opened yesterday. It was but markets were still rattled: Tokyo, Hong Kong, Australia and Chinese stockmarkets all falling sharply, Tokyo and Hong Kong by 4% or more at one stage.
Gold surged past $US1020 an ounce, a new record, oil rose over $US111 a barrel as the US dollar fell sharply against the euro and the yen.
Traders punted on the Fed cutting its Federal Funds rate by 1% to 2% when it meets tonight, our time. That would mean another cut in the discount rate, probably by the same amount.
Bloomberg quoted Gary Schlossberg, senior economist at Wells Capital Management in San Francisco as saying: "Clearly, the Fed is trying to provide more liquidity to prevent a more vicious cycle and race to the bottom. The problem is there’s so much concern about credit quality that now there are solvency issues, and it’s something the Fed has a more difficult time dealing with.”
The Fed lowered its so-called discount rate by a quarter of a percentage point to 3.25%, reducing the spread with the separate, main federal funds rate to a quarter point. In August, at the start of problems, the Fed cut the spread to 0.50% from 1 percentage point.
The Sunday moves came after the central bank agreed to emergency loans to a non-bank in Bear Stearns, for the first time since the 1960s. A week ago, the Fed announced a program to swap $US200 billion in Treasuries for debt including mortgage-backed securities, and the Friday before boosted its auctions and repurchase deals to a new high of $US200 billion a month.
The new facility through the discount window will take a lot of the funding away from the repos and the term auctions.
Mr Bernanke was quoted by US media as saying in his conference call: "The Federal Reserve in close consultation with the Treasury is working to promote liquid, well functioning financial markets, which are essential for economic growth. To that end we took two steps today.
"These steps will provide financial institutions with greater assurance of access to funds," he added.
Another official told Reuters that problems at investment bank Bear Stearns posed a major set of challenges for the financial system as a whole, and the timing of the announcements should be thought of as driven by the situation at that troubled financial institution.
You can’t get much plainer an explanation than that from a central banker. Bernanke’s rare comments make it clear how worried the central bank is. Central bankers are shy creatures and only venture out into the public spotlight in major set piece speeches or appearances before the US Congress (or the Australian Parliamentary Public Finance Committee twice a year).
Reuters reported the Timothy Geithner, head of the New York Fed, which ran the bailout of Bear Stearns and the new lending facility, plus the rate cut, as saying: "This is designed to help get liquidity to where it can help play an appropriate role in helping address the range of challenges facing, particularly asset backed securities markets."
The new lending facility for the primary dealers — big Wall Street firms with which it deals directly in financial markets including regulated commercial banks and non-regulated investment banks– would be kept in place for at least six months.
The Fed said in its statement that the new facility aimed "to improve the ability of primary dealers to provide financing to participants in securitization markets". The loans extended under the new program can be backed by a broad range of investment-grade debt securities as collateral.
