By Neil Irwin and Frank Ahrens
Washington Post Staff Writers
Thursday, January 24, 2008
The stock market soared yesterday afternoon, capping a remarkably volatile day, as new efforts by key players in the U.S. financial system aim to raise enough cash to guard against some of the fallout of the credit crisis.
The Dow Jones industrial average was down 326 points at lunchtime, then finished the day up 299 points, a 5.4 percent swing. For the day, the Dow rose 2.5 percent.
Analysts attributed the turnabout to news that regulators are persuading banks to plow money into bond insurance companies, a crucial and troubled part of the world financial infrastructure. Bank of America said it will raise $6 billion, which would help it continue lending even after massive losses from loans tied to mortgages.
Those pieces of news, combined with the aggressive Federal Reserve interest rate cut announced Tuesday, gave investors solace that U.S. financial institutions are starting to come to terms with the fallout from the slowing economy and credit crisis. Stocks of financial services companies rose a combined 9.2 percent Tuesday and Wednesday.
Analysts were pleased with the signs of stability in the financial sector but cautioned not to assume that the crisis has passed. "The financials have put together two good days," said Neil Hennessy, president of Hennessy Advisors. "But that's like the first two minutes of a basketball game -- you've still got 38 minutes left."
European financial markets, by contrast, continued to plummet, a reflection of contrasting approaches to dealing with the financial crisis and economic downturn on the two sides of the Atlantic. The German stock market was down 4.9 percent yesterday and is down 12 percent for the week.
The Federal Reserve cut interest rates sharply Tuesday to try to arrest a widening financial panic. The head of the European Central Bank took a different approach yesterday.
"Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility," bank President Jean-Claude Trichet told the European Parliament.
That signaled that central bankers in Europe will be strongly disinclined to cut interest rates unless the European economy slows significantly. In the short history of the European Central Bank, and the long history of the German Bundesbank, on which it was modeled, bankers have rarely followed the American tradition of taking aggressive action to try to calm financial markets.
"They don't have the philosophy we do in terms of activism," said Edwin M. Truman, a senior fellow at the Peterson Institute for International Economics in the District. "That is an American way of doing things."
The lack of expected rate cuts from the European bank was not the only problem haunting European markets. Analysts there increasingly expect major European banks to report losses related to complex securities tied to American home mortgages. "German banks are just as involved in these problems as U.S. banks because it is a global financial system," Truman said. "In that sense, the problem is ahead of them."
Since European markets plummeted Monday, European leaders have been saying that their economies are strong and that the current problems are due to weakness in the United States.
At the World Economic Forum, Secretary of State Condoleezza Rice said that the U.S. economy is resilient and will continue to be a "leading engine of global growth."
"I know that many are concerned by the recent fluctuations in U.S. financial markets and by concerns about the U.S. economy," she told a gathering of political and business leaders from around the world in Davos, Switzerland.
The immediate impetus for the rally on U.S. markets was reports that a plan is in the works for major banks to infuse new capital into mortgage insurance companies. These firms protect investors in a wide range of debt products against losses. Losses on complicated mortgage securities have been so great that the insurers are running out of money.
The New York State Insurance Department yesterday led a round of discussions with banks about possible large new investments in the insurance companies, which would keep them from going under or having their credit ratings reduced. A report in the Financial Times yesterday that a cash infusion of up to $15 billion is being contemplated sent shares of bond insurers and other financial companies soaring.
"Bond insurers are part of the safety net of the U.S. financial system," said Robert L. Gay, managing partner of the consulting firm Fenwick Advisers. "If they were allowed to fail, it could cause the kind of chain of events whereby a financial crisis contributes to a recession."
Shares of the bond insurer Ambac Financial Group soared 72 percent, to close at $13.70. Its competitor MBIA closed up 33 percent, at $16.61.
In a positive sign for the housing market, Bankrate reported that mortgage rates fell last week to their lowest level since 2004, at least for people with good credit who are taking out a loan of less than $417,000. In its survey of mortgage lenders, the rate on a 30-year, fixed-rate mortgage was 5.31 percent yesterday, down from 5.42 percent last week and 6.23 percent a year earlier.
Signs of stability in the financial sector notwithstanding, the slowing economy will probably lead to a wider budget deficit this year, the Congressional Budget Office said. The federal government will spend about $250 billion more than it takes in during the 2008 budget year, CBO Director Peter Orszag told Congress, up from $163 billion in 2007.
The 2008 number includes the impact of expected Iraq war spending but does not include the cost of any fiscal stimulus package that Congress passes; packages of $100 billion to $150 billion are being discussed.
The CBO does not forecast a recession in its estimates but does predict slower growth. Orszag indicated that if a recession occurs, the deficit would widen even more.
Unlike European markets, which tumbled yesterday, most stock exchanges in Asia closed up several percentage points yesterday and continued rising in early trading today, though they remained significantly off highs from earlier this year.
Investors were responding to the U.S. Fed's rate cut. The message from the general uptrend, said Huang Yiping, chief Asia economist for Citigroup, was that a "downside risk from the U.S. economy" remains but that it is limited.
Staff writer Ariana Eunjung Cha in Shanghai contributed to this report.
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