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By William Patalon III
Money Morning/The Money Map Report
With Friday’s near collapse and yesterday’s (Sunday’s) outright sale of The Bear Stearns Cos. Inc. (BSC), investors are having to ask themselves this one question: Are we finally reading the last chapter of the U.S. credit crisis, meaning the end is finally in sight? Or are we actually looking at the first chapter of the sequel, meaning this financial horror story still has years to run?
The U.S. Federal Reserve – under the stewardship of central bank Chairman Ben S. Bernanke – is playing a much-more-involved role than usual in the U.S. economy’s health and operation.
Team Bernanke is calling some very creative plays. But whether it’s a viable game plan remains to be seen. The stakes are high: The economic numbers remain weak and the recession talks are escalating with each passing day.
Let’s take a look at some of the long bombs that Bernanke tossed last week.
On Tuesday, Bernanke made the first of his creative lay calls, unveiling a financing arrangement to extract $200 billion in illiquid debt from the U.S. economy, replacing it with U.S. government bonds. The goal: To help breathe life back into the U.S. economy and the American capital markets.
On Friday, the Fed was back on the field again, drafting JP Morgan Chase & Co. (JPM) to help bail out Bear Stearns.
Then yesterday (Sunday), the Fed called its most audacious play of all, announcing a financing arrangement through which JPMorgan will acquire Bear Stearns in a deal that’s valued at $236.2 million.
The Fed also agreed to fund up to $30 billion of Bear Stearns’ less-liquid assets. U.S. Treasury Secretary Henry Paulson said he believes the moves made yesterday will have a major – and lasting – effect on the U.S. capital markets.
In a related move yesterday the central bank approved a discount-rate reduction from 3.5% to 3.25%, effective today (Monday), and also created another lending package that would enable big investment banks to secure short-term loans.
The discount rate is the interest rate that the central bank charges Fed-member banks for loans, using either government securities or some form of commercial paper as collateral. This process establishes a floor for interest rates, since banks set their lending rates just above the discount rate.
“These steps will provide financial institutions with greater assurance of access to funds,” Bernanke, the Fed chairman, told reporters during a short conference call last night. [Editor’s Note: For a related story in today’s issue of Money Morning – an analysis of investor concerns that other U.S. investment banks may be at risk – please click here].
Tomorrow (Tuesday) Federal Reserve policymakers will meet and consider another interest-rate reduction. Most central-bank watchers say that anything short of a three-quarter-point cut by the Federal Open Market Committee (FOMC) on Tuesday will most likely be viewed with disappointment.
And some economists see an even-more aggressive move.
Citigroup Inc.'s (C) U.S. economists on Friday said that they anticipate Federal Reserve policymakers will lower the benchmark Fed Funds rate by a full percentage point, taking it down to 2% from its current 3%, and said “and more cannot be ruled out,” .
Economists led by Robert DiClemente said “aggressive action is needed to stabilize the financial setting.” The economists said Friday’s near-collapse of Bear Stearns Cos. Inc. (BSC) “underscores the current fragility of the system.”
With that perspective, let’s take a look at how all this unfolded last week, as well as how it impacted both the financial markets and the economy.
A Look at the Markets
From the thunderclouds of negativity that hung over the financial markets last week, there was actually a slight glimmer of hope. On Tuesday, the Dow Jones Industrial Average soared by more than 400 points and experienced its best [though short-lived] one-day surge since July 24, 2002.
Did energy traders finally review the inventory numbers and realize that the record oil prices may be way out of whack? Did investors look at current Price/Earnings (P/E) ratios and pounce on the available bargains? Did U.S. Federal Reserve Chairman Ben S. Bernanke’s creativity relieve some pressures of the credit crunch? Or did Wall Street’s biggest nemesis fall [read that to mean plummet] from grace?
Last week, New York Gov. Elliot Spitzer resigned in disgrace after it was revealed that he used the services of a prostitution ring in which some of the “escorts” charged upwards of $3,000/hour. The once “holier-than-thou” N.Y. Attorney General previously took on the titans of Wall Street and won battles against investment banks, mutual fund companies, insurance giants, and even entire stock exchanges. When news of his “extracurricular activities” hit the press, many Wall Street notables rejoiced. Perhaps that euphoria contributed to the emergent – but brief – energy within the equity markets.
In reality, while the plight of the governor undoubtedly caused more than a few chuckles [to say the least], it was Fed Chair Bernanke who actually stole the show.
While most economists have been talking incessantly about a reduction in the benchmark Federal Funds Rate at the policymaking Federal Open Market Committee (FOMC) meeting this week, Bernanke last week found an innovative way to inject another $200 billion into the U.S. financial system and to relieve pressures on mortgage-related securities that are “under water.” By expanding the scope of pledge-able assets used as collateral, Bernanke hopes that major investment players will regain some confidence in the mortgage markets. The Fed acted without once again cutting interest rates [at least until later this week, as you’ll see], a campaign that has contributed to the dollar’s dramatic weakness, growing inflationary concerns and possibly even higher oil and commodity prices. [Editor’s Note: To read Money Morning Investment Director Keith Fitz-Gerald’s widely circulated investment analysis of the steps he believes the Fed must take to right the U.S. economy, . The report is free of charge].
Investors initially welcomed the Fed’s move; after that, however, it became clear that investors once again were focused on the long-term consequences.
The parade was short-lived as oil surged to record after record and topped $110 a barrel, despite a very positive inventory report that [should have] underscored that there was a more-than-ample supply to keep up with current demand. Instead, crude surged on the dollar’s continued weakness, leading certain analysts to repeat claims that speculation – and not basic economics – is controlling the markets. Meanwhile, gold finally eclipsed the psychologically important $1,000 an ounce level.
The strong day caused investors to refocus on P/E ratios as they attempted to determine the “fair value” of stocks. According to a Reuters study, the Standard & Poor’s 500 Index trades at about 13 times estimated 2008 earnings, compared to an average P/E of 16.5 [with the average dating back to 1989]. Then again, many analysts revised their corporate earnings estimates [much lower in many cases].
As the week unfolded, impatient investors realized the Fed’s innovative moves would not have an immediate impact and they again eyed the weak economic data, and the rising oil and gold prices. A Fed/JP Morgan Chase & Co. (JPM) bailout of one-time giant Bear Stearns Cos. Inc. (BSC) only fueled investor woes.
Suddenly, the stock market’s best day in five years was forgotten as the indexes experienced significant volatility and pared back those gains. As for Spitzer, perhaps a $1.4 billion settlement [sound familiar?] would be poetic justice.
A Look at the Economy
While certain major economists have been warning about the dreaded “R” word for the past few months, some are actually going out on limb now with their views that a recession may already be under way [or, at least, pretty darn close]. In fact, a recent Wall Street Journal poll found that more than 70% of those economists surveyed believe the country is now mired in a recession.
JPMorgan’s chief economist claimed the downturn actually got under way in January. Lehman Brothers Holdings Inc. (LEH) analysts revised their growth estimates and expect the economy to fall by 0.5% in the first quarter, with the contraction widening to a 1% decline in the second. By definition, two straight quarters of negative growth translates into a recession. Over at Merrill Lynch & Co. Inc. (MER), eternal pessimist David Rosenberg believes that this downturn will far surpass the 1990-91 recession and will rival the hurt felt in the 1970s.
Weekly Economic Calendar
|The Week Ahead|
|March 17||Industrial Production (02/08)|
|March 18||PPI (02/08)|
|Housing Starts (02/08)|
|Fed Policy Meeting Statement|
|March 20||Initial Jobless Claims (03/15/08)|
|Leading Eco. Indicators (02/08)|
Turning to the data, a weaker-than-expected February retail sales number confirmed that many consumers still lack the confidence to return to the malls and purchase anything but the basic necessities – and at discounted levels, wherever possible. While an unchanged February Consumer Price Index report depicted the CPI’s most favorable reading in six months, economists discounted the report because it failed to factor in the recent record climb in oil prices. The Fed meets again this week to further change monetary policy. Prior to the creative financing move last week, most Fed-watchers were calling for a three-quarter-point reduction in the Fed Funds Rate. While many still believe that a move of such magnitude is still in the cards, they realize that Team Bernanke can’t help but consider the plunging dollar, soaring oil and gold prices, and ongoing recession/inflation/stagflation fears. On a bright note, the sooner the recession begins, the sooner it ends – or so the survey implies.
Coming up in the week ahead: Industrial Production (Monday), PPI (Tuesday), Housing Starts (Tuesday), Fed Policy Statement (Tuesday), and Good Friday (Friday).
News and Related Story Links:
- Money Morning News: Fed Plan Sends Dow Soaring Over 400 Points.
- Money Morning Financial Analysis: Dollar in Dumps, Sends Commodities Soaring Higher.
- Money Morning Investment Opinion: .
- Bloomberg News: U.S. Stocks Advance Most in Five Years on Fed's Liquidity Plans.
- MSNBC.com: Fed drops lending rate a quarter-point.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.