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Fed cuts discount rate, stands ready to do more
Friday, August 17, 2007
A short while ago, the Federal Reserve issued two press releases. The first statement announced that the discount rate had been cut from 6.25 percent to 5.75 percent and the second statement made clear that they were standing by, ready to do more.
Presumably, doing more would include formalizing what appears to be a 50 basis point cut to the target Federal Funds rate, a rate cut that has effectively been in place for the last four days.
As shown to the right, what has transpired in credit markets over the last few days is not quite a 9/11 event, but it is the closest thing to such a credit melt-down in many years. Unless the Federal Reserve intends to withdrawal liquidity from the banking system, the formalization of a rate cut is all but a done deal.
Recall that the Federal Reserve controls short-term interest rates by buying and selling in via open market operations - after being forced to do a lot more buying than selling in recent days, the effective Federal Funds rate has slipped by a half percentage point or more. In order for short-term rates to rise back to their target rate of 5.25 percent from the recent 4.5 to 4.75 range seen during most of the week, they would either have to sell into the market or stop making purchases.
Many observers have already noticed that the "effective" rate has diverged from the "target" rate for days now - the longest deviation of this magnitude since 9/11.
While data is not yet available for yesterday's effective rate, the second announcement from the Fed today seems to make clear that if the situation does not improve sufficiently for the Fed to withdrawal funds from the banking system, a reduction in the fed funds rate will be formalized within a matter of days.
11 comments:
Here are some related stories/background info on this subject - I was getting something differet ready to go this morning, but breaking news has resulted in a change of plans:
Calculated Risk - Fed Funds Target vs. Effective Funds Rate
WSJ MarketBeat Blog - Has the Fed Already Eased?
WSJ Economic Blog - How Does the Fed Keep Rates Near Its Target? A Primer
Larry Kudlow's Blog - The T-Bill Message for Bush & Bernanke
WSJ - Has Fed Quietly Eased Stance? ($)
So does this let the hedge funds who were heretofore insolvent off the hook?
No - I think it's more of a confidence booster to get people to buy more stocks and to get banks to lend more money.
i dont have a job but i bought a new house in the inland empire for $1milion dollars. i got money back at closing (really the money was just put on the back of my mortgage) and i bought a new pickup a mustang a sand rail and a harley. i then refi'd and bought a ski boat and then bought a vacation house on the lake. i took a trip to hawaii and then to vegas. lots of fun.
i bought all new furniture for the house. i eat out 3 meals a day and i have season tickets for both the football season and the baseball season. i keep all my kids in daycare all day which costs a fortune but man i couldnt stand having to take care of them all day. it does costs $1000 a week for each kid but well worth it.
the wife goes shopping at neiman's about 3 times a week and we have like 15 credit cards with a balance of about $150k.
i have all the yard work done by a landscape company and i have a guy clean the pool.
did i mention i dont have a job...........i have refi'd like 3 times so far!
man-is this not a wonderful country!!!!!!!!
More good stuff at the WSJ economics blog:
Odds Improve for Fed Funds Rate Cut
Explaining the Discount Window
Economists React: ‘Lifting the Wizard’s Curtain’
Favorite comment:
Pool goes on bloomberg telling everyone they wouldn’t act until they see ACTUAL proof the real economy is being affected; less than 24 hrs. we witness Helicopter Ben at work.
Obviosuly this move by the Fed’s is a clear signal that they are bending over backwards too help out speculators of all forms. Inflation ? Who cares ! We need to bail out the speculators !
Thanks Helicopter Ben !
Comment by Solomon Goldberg - August 17, 2007 at 9:48 am
Sowood founder apologizes to it's Investors
from The Boston Globe
A contrite Jeff Larson, founder of Boston hedge fund Sowood Capital Management, spoke to his clients for the first time yesterday and tried to explain how events of recent weeks iped out more than half of their $3 billion investment.
"You entrusted us with the management of your money, and we lost a lot of it, to say the least," Larson said. "No apology is sufficient."
He spoke on a conference call with investors for about 10 minutes but did not take questions.
Larson said Sowood was unwinding remaining positions and expected to return about $1.4 billion to investors, slightly less than the $1.5 billion estimated earlier. Sowood agreed this week to sell most of its debt securities, which had caused the fund's problems, to Citadel Investment Group of Chicago at a deep but undisclosed discount.
It has been an abrupt end for Sowood, launched three years ago by Larson when he left his job at Harvard Management Co.
investing part of the world's largest university endowment. Harvard Management, which lost about $350 million in Sowood's demise, had been Larson's principal investor when he opened the hedge fund's doors.
State pension officials in Massachusetts say they lost about $30 million in their Sowood investment. The nonprofit Boston Foundation estimates it will recover only about $10 million from its $28.6 million direct investment in the hedge fund.
Sowood wrote to clients Monday explaining broadly how the fund's investment strategy had gone disastrously wrong in a matter of weeks. Larson yesterday described in greater detail events inside Sowood that pushed the firm's portfolio into a financial crisis.
He said Sowood borrowed heavily to make investments the firm believed were low risk and backed them up with a hedging strategy intended to act as insurance in case anything went wrong. But markets reacted much differently than Sowood expected, driving down the price of its securities and rendering its hedges ineffective.
Sowood tried to get out of trouble by selling some of the securities, but demand dried up and Sowood found few buyers for sinking assets purchased with mostly borrowed money. That led to a kind of financial death spiral. Finally, Larson said he spent last weekend negotiating a big deal to avert a complete financial disaster he feared could have occurred this week.
"We did this in order to avoid what we believed was the very real possibility of counterparties seizing our collateral and liquidating or auctioning our positions," Larson told investors yesterday. "In such an uncontrolled process, we believe there was a high likelihood that little to no net asset value would remain for our investors."
Larson said Sowood began building up investments in senior debt securities of high-quality companies with strong collateral this year. He said Sowood took concentrated positions in some cases, but did not identify them.
One obvious risk to that strategy was the way corporate debt markets were behaving earlier this year. Investors normally demand higher interest rates on corporate debt compared with nearly risk-free alternatives like US Treasury notes. But they had been unusually accommodating to companies borrowing money, and the rate gap between risk-free debt and corporate securities was squeezed hard. When the market inevitably reverted to more normal rates, corporate debt could lose value.
Sowood tried to protect itself against that threat and the possibility of default at individual companies with a strategy betting against more junior debt issued by the same companies. If anything went wrong, the less-secure junior debt should suffer at least as much in price as the better-protected senior borrowing. Sometimes Sowood bought "put" options in the stocks of the same companies, intended to accomplish the same thing by profiting in a decline.
Larson said Sowood lost 5 percent when its corporate debt portfolios began to sag in June but no one at the firm considered it a serious threat. "Unfortunately, we were wrong," he said. "July was not just a repeat of June, it was radically worse."
Potential risk in the corporate bond market became a gale-force reality. As the price of Sowood's senior-debt securities sunk, the more junior borrowings did not respond as expected. Stocks generally went up, not down. Sowood's strategy wasn't working, and it couldn't find enough buyers for its senior securities.
The problem began a crisis by the week of July 23. "Each day brought greater and greater losses," Larson said. Sowood's securities that acted as collateral for its loan were being marked down drastically in value by brokers. Soon, Sowood's situation became hopeless.
"A loss of this magnitude is as devastating to us as it is to you," Larson said.
Yeah, right.
http://tinyurl.com/352nab
I take back everything nice I ever said about Helicopter Ben.
You're going to have change the blog name again, you know. Ben now shares the blame.
It sure didn't take much for him to cave.
I took what Pool had to say about waiting on rates to be the Fed decision, now today I wake up to find a knife in the back. Good going Uncle Ben, socialism for the top, free cheese for the rest, oh ya no more free cheeese.
From the WSJ article:
St. Louis Federal Reserve President William Poole, in an interview with Bloomberg Television Wednesday, made no secret of his opposition to any Fed rate cut before its next scheduled meeting, Sept. 18. "There's no need for the Federal Reserve, unless there's some sort of calamity taking place, to make a decision before the next meeting," he said, according to a Bloomberg account of the interview. "If the data confirm the market's view that the economy is sagging, we'll have to decide whether to share that view.''
Mr. Poole added that he sees no sign that the subprime-mortgage rout is harming the broader U.S. economy, and an interest-rate cut isn't yet needed. "I don't see any impact as yet on the real economy or on the inflation rate," he said. "Obviously, there could be an impact, but we have to rely on some real evidence."
Asked about the remarks, Fed spokeswoman Michelle Smith said, "President Poole is speaking for himself and not for the committee."
Mr. Poole, who is among the five regional Fed bank presidents with a vote on the Fed's policy committee, is not always the best weather vane. On April 10, 2001, he acknowledged speculation that the Fed might cut rates before its May 15 meeting, but said, "There are compelling times when quick action is necessary, but this is not one of them." On April 18, 2001, the Fed cut rates by a startling half-percentage point.
It is good to see more people tracking the effective rate and note that some recent individual Fed fund loans occurred at 0% interest.
Should Bernanke Resign?
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