On Wall Street: Fed rate cut causes barely a ripple
Never mind that at three-quarters of a point, Tuesday's move was the biggest cut for the US benchmark interest rate in more than two decades, and the biggest emergency cut the Fed has made between scheduled meetings. Instead, Wall Street got its shot in the arm from a very different place. News of a potential rescue plan for the embattled bond insurers, the details of which remain far from clear, helped bring about a 600-point intraday swing in the Dow Jones Industrial Average on Wednesday, lifting US stock markets to a finish that was deeply in positive territory. In contrast, the central bank's extraordinary action, a bid to arrest deterioration in the US economy and stem a wave of selling in world stock markets - received a more lukewarm reception. European and Asian stocks had a short-lived rebound, while in the US, the S&P 500 pared most of its early losses but still closed 1.1 per cent lower on the day. So why such apparent indifference to one of the Fed's most dramatic moves? Investors worried that the cut, coming as it did just eight days before the Fed's scheduled meeting, looked panicky. Indeed, one investor described the move as "not unlike yelling fire in a crowded movie theatre". But more important, a cut in interest rates does not cure the troubles that have plagued US markets since the credit squeeze took hold last summer. Certainly, by lowering short-term interest rates, the Fed's move has made it easier for banks to borrow short and lend long - normally a stimulus for lending. But it cannot patch up the holes in bank balance sheets caused by imprudent bets on complex and risky securitisations of subprime mortgage bonds, which have since suffered sharp drops in value. Banks are also still holding on their balance sheets more than $230bn of high-risk loans and bonds needed to finance buyout deals struck in the first half of 2007. Amid highly volatile secondary markets, placing such transactions with investors has become increasingly challenging. The tally of bank writedowns related to their problems passed $100bn this month, and more losses are widely expected, forcing banks to turn to foreign investors to bail them out with fresh capital. Banks' ability to make new loans is thus severely constrained, meaning that a kick start for the credit markets could still be some way off. It could also mean ongoing uncertainty for the housing market. After all, the last thing banks want on their devastated balance sheets is more exposure to mortgages, even if the Fed's interest rate cut means lower mortgage rates will attract borrowers wanting to refinance. Stock markets continue to be troubled by the looming issue of so-called "counterparty risk" - the danger that a trading partner fails to make good on their obligations. Concerns have been stoked by the shoddy risk-management procedures exposed at several major institutions - the most vivid demonstration of which was the $7bn hit at Societe Generale this week, caused by a single rogue trader. More pressing have been fears that bond insurers such as MBIA could lose their crucial triple-A ratings. Bond insurers Ambac and SCA have already lost their the triple-A stamp from Fitch, and further downgrades are possible. This would have serious knock-on effects for trading partners and for holders of insured bonds, which would all be downgraded. The result would be more writedowns for banks with exposure to the bond insurers, and more pressure on balance sheets. Hopes that regulators might persuade banks to cough up $15bn to support the bond insurers thus received a euphoric welcome from equity markets that had been uninspired by the Fed's move. But bank support for the plan is far from certain, given their own balance sheet concerns. Banks also feel stung by a failed bail-out plan for ailing off-balance sheet vehicles. If this plan goes the same way, then investors will have to look elsewhere for cheer. ***
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The Federal Reserve's emergency interest rate cut was almost treated as a footnote by investors this week.