Fed's bold $200 billion move
The central bank's unusual cash infusion aims to keep banks lending.
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At the same time, on Monday some analysts became concerned about Bear Stearns, one of the nation's primary dealers in Treasury securities. The investment company's stock was falling and there were reports it was costing more money to fund its borrowing costs. A company executive told CNBC it was not having any liquidity problems.Skip to next paragraph
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One of Fed chairman Ben Bernanke's hobbies is studying the causes of the Great Depression. At the start of the Depression, many small banks that had speculated went out of business. Then, larger, more established banks were squeezed.
"There was a whole cascade effect," says Mr. Roberts. "So there is concern if one dealer has a problem, it could cascade to another dealer because once the domino starts to fall it becomes hard to stop."
Move spurs market rally
The Fed's actions have met with wide approval on Wall Street. On Tuesday, after the announcement was made, the Dow Jones Industrial Average leaped 416 points. On Wednesday morning, the market's rally continued with the Dow up another 132 points.
"The market is celebrating the Fed's action here," says Phil Flynn of Alaron Trading in Chicago. "The problem was the market felt the Fed's prior actions were not viewed as big enough or effective enough to make the banks want to lend money."
Mr. Flynn says Wall Street is also relieved the Fed recognizes that it needs to do more than cut interest rates. Since Sept. 17th, the Fed has lowered interest rates by two and a quarter percentage points.
"However, it was having a negative effect, the dollar is down and we're getting commodity inflation that is putting stresses on the economy," says Flynn. "This is another weapon in the Fed's arsenal."
In fact, some economists believe the Fed's latest move will mean the central bank will be under less pressure to lower interest rates sharply when it meets on March 18. Up until yesterday, the credit markets were expecting a three quarters of a point interest rate drop.
A temporary relief
Despite Wall Street's optimism, economists warn banks are likely to continue to be difficult lenders. Mortgage defaults are rising as are foreclosures. "These are genuine losses and the banks will have to write down this debt and see their capital erode," says Mr. Kasriel, who compares the current situation to the early 1990s when the banking system saw some substantial losses.
"It takes time to rebuild capital, to rebuild profits," he says.
However, Roberts says the Fed's move gives the banks some breathing room. "Bernanke's Fed is being innovative in dealing with this."
The Fed's move has helped to change the mood of the markets. "I think it's more of a psychological kind of move," says Mr. Eisenbeis. "It's a step to improving the Fed's credibility, it's showing us they are on top of things."