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Federal Reserve injects $38 billion into credit markets

Mr Roger K. Olsson | 11.08.2007 06:02 | Analysis | Other Press | London | World

Giuen Wealth Field



Friday, August 10, 2007


Aug. 10, 2007 (McClatchy-Tribune News Service delivered by Newstex) -- WASHINGTON -- The Federal Reserve flooded nervous financial markets with three big injections of cash on Friday to head off concerns that a spreading credit crunch could cause a Wall Street meltdown.
The central bank's emergency action appeared to stem a panic atmosphere that had gripped the stock market earlier in the day, but volatile trading for most of the day gave little confidence that the medicine would be long-lasting.
The Dow-Jones (NYSE:DJ) Industrial Average ended down by 31.14 points and the Standard & Poor's (NYSE:MHP) 500 Index eked out a gain of .55 of a point. At one point earlier in the day before the Fed had completed all its money injections, the Dow-Jones average had fallen 212 points.
With the closing bell, attention turned to next week to see whether the Fed will continue to pump even more money or 'liquidity' into the markets or whether it will have to consider an interest-rate reduction. Odds of an interest cut at its September meeting increased with some analysts saying a cut could come sooner.
The central bank acted in the wake of signs that problems in the 'sub-prime' mortgage market for riskier loans had begun to spread to other sectors, and even reached overseas. Holders of some mortgage-backed securities have seen losses mounting and housing financing has become more difficult.
Announcing that it is 'providing liquidity to facilitate the orderly functioning of financial markets,' Chairman Benjamin Bernanke's central bank pumped a total of $38 billion into credit markets on Friday on top of $24 billion a day earlier. It was reminiscent of the Fed's emergency cash infusion after the Sept. 11, 2001, terrorist attacks.
It had little choice but to do so. The interest rate that it seeks to control, the 'federal funds' rate on short-term loans between banks, had jumped to nearly 6 percent Friday because of tightening credit, even though the Fed has vowed to keep that rate at 5.25 percent.
It took three injections of cash into financial institutions to accomplish that goal. And there could be more: The Fed said it will 'provide reserves as necessary' to keep the rate at 5.25 percent in the future.
'The first thing it has to do is maintain orderly markets,' said David Wyss, chief economist at Standard & Poor's, the credit-rating firm. 'If it doesn't, it loses all control.'
President Bush had no comment, but spokeswoman Dana Perino in Kennebunkport, Maine, where Bush is vacationing, said his advisers 'are keeping a very close eye on all market activity.'
Opinion was divided on whether the central bank's action will do much good with many economists taking wait -and-see attitude.
To some, reducing interest rates further now would essentially rescue those who engaged in unwise credit practices, and a bailout is something that the Fed has long sought to avoid. Still, some analysts said the Fed's action still smacked of a stock-market bailout.
The Bernanke Fed has shown more concern about inflation than economic growth and appears to be 'more of an academic Fed and less pro-active' than that of former Chairman Alan Greenspan, said Diane Swonk of Mesirow Financial in Chicago.
There aren't many options for the central bank. Only Tuesday, the Fed had shrugged off problems in the credit markets and decided to hold interest rates steady. To back off that statement now and cut rates quickly could damage the Fed's credibility, said economic consultant Joel Naroff.
The central bank could have taken its chances and not acted so swiftly with such a big infusion, but that would have been risky, especially since markets in Europe had swooned a day earlier after a French bank's problems with mortgage-backed securities.
Angelo Mozilo, chief executive of Countrywide Financial Corp. (NYSE:CFC) , the biggest U.S. mortgage lender, told Bloomberg News he was optimistic. 'The action of the Fed (Friday) may change everything,' he said. 'It certainly provides liquidity to the banks. I feel very positive about the move.'
(EDITORS: STORY CAN END HERE
The central bank did something unusual as it drove the federal funds rate back down to 5.25 percent. It purchased mortgage-backed securities from financial institutions rather than government securities as it usually does in such operations. It put cash 'where it was needed the most,' said Mark Vitner of Wachovia (NYSE:WB) Bank in Charlotte, N.C.
Under highly technical repurchase arrangements, the Fed requires these institutions to buy back these mortgage-backed securities on Monday, so that the cash infusion is only temporary. But it could repeat the process if needed.
Another option would be to allow financial institutions to borrow directly from the Fed through its discount window, though the discount rate is 1 percent higher than the federal funds rate. Vitner said the Fed might consider reducing the discount rate, so that more lenders would be inclined to use it.
(EDITORS: STORY CAN END HERE
Dan North, chief economist at Euler Hermes (OOTC:EUHMF) ACI, an Owings Mills, Md. firm specializing in insuring accounts receivables, said the credit crunch has spread beyond the housing industry. 'It's making the credit-granting community shiver,' he said. 'Liquidity is drying up in a lot of areas.' He added that he saw no quick fix.
Naroff said in refusing to reduce interest rates at its last meeting, the Fed 'basically said the sub-prime issue was much ado about nothing.' In Naroff's mind, this amounted to downplaying a problem that had been building for months.
Bernanke is likely to be criticized for waiting too long. In speeches and testimony to Congress, he has said that the housing correction appeared to be largely contained.
------
(c) 2007, Chicago Tribune.
Visit the Chicago Tribune on the Internet at  http://www.chicagotribune.com/
Distributed by McClatchy-Tribune Information Services.
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