The Federal Reserve Tuesday decided to lend $200 billion to primary dealers on a 28-day basis, hoping to restore greater liquidity in the credit system. Twenty investment firms who function as primary dealers will be able to borrow Treasuries against Fannie Mae and Freddie Mac issued-collateral backed mortgage securities. To make even more money available and flow through the system, AAA-rated mortgage securities that banks issue will also be accepted as security. These triple-A mortgage-backed securities have been the ones investors have been reluctant to purchase recently, with the concerns due to risk. The government backed Fannie Mae (NYSE: FNM) and Freddie Macs (NYSE: FRE) have been regarded as safer investments.
The Fed hopes to stimulate the flow of lending which has still been slow despite several recent interest rate cuts, due to concerns over repayments. The Fed’s implicit concern is that they want to stop the growing credit problems from spreading through the entire credit market and the economy. This move, coupled with the lowered interest rates, is an attempt to address the liquidity concerns that the Fed sees with the scaled back lending. With banks more able to borrow money, the hope is that they will be more willing to lend.
Whether this will help re-create a favorable climate for lending remains to be seen. Banks have begun to use whatever cash they can garner to strengthen their balance sheets in the wake of widespread writedowns due to bad loans, either in the subprime area or closely-related area of collateralized subprime packages. So consumers and small businesses may not see much immediate impact in the credit area. Small business loans, as well as consumer loans, such as auto loans and student loans, have now been affected.
It is axiomatic that the Federal Reserve can’t compel banks to lend, and this phase of the credit market problems echo back to the 1991 lag where interest rates came down but banks were slow to lend, so businesses and consumers were slower still to feel the relief. With the problems of continued weakness on the balance sheets of some of the lenders, including both mortgage companies and banks, financial institutions may take some time before they feel the psychological push to lend. When the financial institutions are more comfortable with the risks in the credit markets, that’s when they tend to lend more widely. With the announcement that Citigroup, Inc. (NYSE: C) is scaling back its mortgage lending, and the fallout from Countrywide (NYSE: CFC) still to be digested, we may have a while before the credit markets are restored to health.
The stock market initially loved the move. Trading opened Tuesday morning in light of the announcement with the Dow roaring, and ended up with more than 416.66 points at the close, up to 12,158.81, while the S & P 500 was up 47.28 to 1,320.65, and the Nasdaq joined in at plus 86.42, finishing at 2,255.78. Today’s close, however, told a different story. After initial gains, the final hour, often dominated by institutional trading, saw the averages in the red, with the Dow off 46.57 at 12,110.24. The other averages reacted similarly. Whether this lending infusion will signal a lasting cure to the credit market’s blues—and that seems to be the Fed’s goal– or is just another a temporary jolt in the averages is dependent on time.
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