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Fed Cuts Interest Rate to Stem Panic
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Lower rates, in addition to making it less expensive for consumers and businesses to borrow, stimulate the economy in other ways. They cause weakness in the price of the dollar, which helps U.S. exporters. And they make banks more profitable, which in the current crisis could allow them to rebuild their capital positions and get on more solid footing.
The rate cuts, coupled with proposed tax cuts and spending increases, could shore up confidence among companies and consumers. But they do not directly address the root cause of the crisis -- a set of bad bets made by financial players all over the world over many years that roiled the fundamental business of lending money.
Those who trade in complicated debt securities based on mortgages or other kinds of loans said those markets generally remained troubled despite the rate cut.
"Everyone is still pretty spooked right now. People are still in a wait-and-see mode," said Kerry Kantin, who covers the trading of buyout loans for Standard & Poor's Leveraged Commentary & Data.
Policymakers have struggled to contain the credit crunch because so many financial firms tied their fortunes to the housing industry by buying mortgages, packaging them and trading them like securities. That business started to spread the risk of making the loans across many parties and, for years, it generated huge profits and fees for Wall Street's biggest banks. Financial firms, hedge funds and investors around the world rushed to get a piece of the action.
Now, as defaults and foreclosures soar to record levels in the United States, these mortgage securities are plummeting in value, and even the most savvy investors aren't sure what they are worth. Firms around the world, facing huge losses, can't sell the securities, and their ability to support all kinds of loans is threatened. The cash spigot is closing.
"Financial engineers for the past five years created a whole bunch of defective products that are nothing but blind pools of bonds and loans that are of very poor credit quality, but through the magic of financial alchemy were sold as good credits," said Ed Yardeni of Yardeni Research.
This "credit recession," as some Wall Street analysts have termed it, is in some ways more dangerous than other downturns the nation has faced because it threatens both consumer and business spending.
Fed officials are particularly concerned about the financial health of bond insurers, some of which may be close to failing. Those firms help municipalities and companies with weak credit borrow money, but over the past few years they also delved into the business of providing insurance for mortgage-backed securities.
The insurers now have to cover more losses than they can afford. If any of them fail, the value of the municipal and corporate bonds they insure would suffer a huge drop.
Nearly 5,000 bonds insured by Ambac Financial Group were downgraded yesterday and have dropped in value. On Friday, Fitch Ratings downgraded Ambac itself.
The rating of another bond insurer, ACA Capital Holdings, was cut from investment grade to near junk by Standard and Poor's last month after the company revealed that it faces $60 billion of mortgage-security insurance losses that it can't pay. Yesterday it won a month's grace to unwind these contracts from the people who bought the insurance.
New York insurance regulators, officials of the Federal Reserve Bank of New York, and many of the biggest firms on Wall Street are discussing how to infuse new capital into the bond-insurance companies to prevent the losses from rippling through the financial system.
The New York State Insurance Department has persuaded billionaire investor Warren E. Buffett's company, Berkshire Hathaway, to enter the market for municipal bond insurance. (Buffett is a director of The Washington Post Co.)
"What's going on is the unwinding of probably the biggest credit bubble in history," said David Shulman, senior economist at the UCLA Anderson Forecast. "It will take a while to undo this, and it could get very messy."
