End of the tunnel seen in Bear Stearn collapse
NEW YORK: Less than a week ago, it seemed as though the sky were falling on Wall Street when the unraveling of Bear Stearns sent global financial markets into panic mode.
Then the Federal Reserve swooped in. Its liquidity action and its brokering of a deal for JPMorgan Chase to take over Bear Stearns made investors less fearful about a possible crippling of the U.S. banking system.
Bear Stearnss fall to the brink of bankruptcy and the aggressive moves by U.S. policy makers have led many investors to believe that these events mark the beginning of a bottoming process.
For everyone who still thinks that stocks will not hit a bottom until the Standard Poors 500 falls into the bear markets grasp, never mind.
“We are in a bottoming process, but it will really be a process because healing of this credit crisis does take time,” said Dan Fuss, vice chairman of Loomis Sayles, an investment company that oversees more than $100 billion in fixed-income securities.
What gives Fuss and other major investors reason to believe that a bottom is in the making is that in nearly every previous one, there typically has been a huge failure of an institution that has led to extreme policy responses.
Think Enron, WorldCom and Long-Term Capital Management.
“It usually took a big entity to fall over for aggressive, creative regulatory policy to develop,” said Bob Doll, vice chairman and global chief investment officer of equities at BlackRock, which manages more than $1.1 trillion in assets.
“Thats what we saw with Bear Stearns collapsing and the Feds extraordinary response to it. And thats why confidence is improving.”
Bear Stearns, which had been heavily exposed to the faltering mortgage market, faced a classic bank run as it burned through cash and lost access to financing when clients furiously pulled assets and unwound trades.
To make matters worse, fears abounded that Lehman Brothers, another major U.S. investment bank, could suffer a similar fate as Bear.
“The Fed was trying to blunt what could have been a snowballing effect of a lack of faith in the financial system,” said Keith Wirtz, president and chief investment officer at Fifth Third Asset Management.
“The Fed saw that they had to do something absolute to stifle what could have been a developing crisis of a full-fledged lack of faith in the investment banking sector, which could have eventually crept into the commercial money banks as well.”
Before Monday, Lehman Brothers, Merrill Lynch, and even Goldman Sachs watched their stock plummet. From the end of June 2007, which was the start of the credit turmoil, to Friday, before the Fed stepped in, Goldmans stock was down 28 percent, Lehman lost 48 percent, and Merrill also dropped 48 percent.
Moreover, the Amex Securities Broker-Dealer index was down 48 percent.
On Tuesday, the Fed cut interest rates by three-quarters of a percentage point to 2.25 percent, the sixth time it has slashed its fed funds rate target for overnight bank loans.
It was not the rate cut, however, that prevented a near meltdown in stock markets.
The Fed dusted off a Depression-era rule to let securities firms borrow directly from the Fed through its “discount window,” helping restore investors confidence.
That decision was announced along with the Feds promise to underwrite JPMorgans takeover of Bear for the fire-sale price of $2 a share. It helped turn the mood around on Wall Street.
From now on, any bank in a liquidity jam will be able to go directly to the Federal Reserves discount window and trade in its hard-to-sell assets, like mortgage bonds, as collateral for highly liquid government bonds or cash, which it can in turn use to fund its short-term liabilities and keep trading.
“The big news this week was not the Feds 75 basis points on Tuesday,” said Doll, the BlackRock vice chairman. “It was what they did with opening the discount window.”
This week, the Fed cut the discount rate twice - in an emergency move Sunday, when it announced JPMorgans deal to buy Bear Stearns and again Tuesday at its regular meeting.
On Wednesday, the federal government came up with another tonic for troubled times. The regulator of Fannie Mae and Freddie Mac, the two biggest U.S. home financing companies, relaxed the capital rules governing them and gave them permission to pump $200 billion more into the struggling U.S. mortgage market.
Goldman shares were trading Wednesday at $166.49 per share, up from the close Friday of $156.86, while Lehman was trading at $42.23 per share, up from $39.26 Friday. As for Merrill, its shares closed at $41.45, down from $43.51 Friday.
