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March 17, 2008
Fed Acts to Avert Panic
Over the weekend, the Federal Reserve opened a $30 billion line of credit for the purchase of troubled investment bank Bear Sterns and promised an open ended lending program for the biggest investment firms on Wall Street:
In a third move aimed at helping banks and thrifts, the Fed also lowered the rate for borrowing from its so-called discount window by a quarter of a percentage point, to 3.25 percent. This preemptive strike by the Fed is due partly to the psychology of the market a this point. As liquidity dries up, cash becomes scarce and those institutions holding a lot of mortgage securities don't look like good bets for a loan.
The moves amounted to a sweeping and apparently unprecedented attempt by the Federal Reserve to rescue the nation’s financial markets from what officials feared could be a chain reaction of defaults.
After a weekend of intense negotiations, the Federal Reserve approved a $30 billion credit line to help JPMorgan Chase acquire Bear Stearns, one of the biggest firms on Wall Street, which had been teetering near collapse because of its deepening losses in the mortgage market.
In a highly unusual maneuver, Fed officials said they would secure the loan by effectively taking over the huge Bear Stearns portfolio and exercising control over all major decisions in order to minimize the central bank’s own risk.
Bear Sterns was one of these cash strapped companies and margin calls made its position untenable. In steps J.P. Morgan and for less than 10 cents on the dollar, purchases Bear Sterns. The buy out is backed by the Fed so Morgan's risk is zero.But beyond that, there is the possibility of panic since other big Wall Street firms have assets tied to the mortgage security markets. The Fed acted to make sure that there is plenty of cash for these firms to borrow to meet their obligations.
As I have said on these pages before, I am no expert. I can only report what others are saying about this mess. And the news, as far as I can tell, is pretty grim. We are very close to a financial meltdown that would affect everyone in America and could precipitate the deepest recession since the end of World War II.
The Feds actions are addressing the immediate problem. But even just a few months down the road, if the rate of delinquency and failures continue in the mortgage market, it may get to the point where even the Federal Reserve will be unable to stop the bleeding.