The US Federal Reserve has mounted the biggest rescue operation since World War II to head off “a meltdown in the global financial system”, said Larry Elliot in The Guardian.
At the weekend, it orchestrated a rescue of the near-bust Bear Stearns, America’s fifth-biggest investment bank. There was a further cut in the discount rate (at which it lends to banks) and, in a measure not seen since the 1930s, it has allowed investment banks, not just commercial banks, to borrow directly from it.
And this week it slashed the benchmark interest rate by another 0.75% to 2.25%; never before has it cut so much when rates were already so low. Along with better-than-expected results from Lehman Brothers, Morgan Stanley and Goldman Sachs, the cut gave equities a boost, with the S&P 500 posting its biggest daily jump since late 2002 on Tuesday.
Will this help?
Central bankers are “like toddlers” driving toy cars, as Anthony Hilton put it in the Evening Standard; “they think they are steering but the controls aren’t attached to anything”. Pumping money into the system and lowering the price of credit can’t change the fact that banks are reluctant to lend to each other as they might not get the money back.
Falls in mortgage-related and other loans have prompted institutions to sell them, further lowering their value and fuelling concerns over solvency. With the housing market, the root cause of the credit squeeze, still slumping – Morgan Stanley is pencilling in another 10% slide over the next year – the outlook is hardly encouraging.
Plenty more writedowns ahead
Meanwhile, the results from Goldman and Lehman also highlight the prospect of further write-offs for banks. The respective 53% and 57% annual fall in profits were lower than feared; the banks were helped by being far more diversified than Bear Stearns – Goldman got a big lift from its commodities division – and Lehman soothed fears by confirming that it had plenty of liquidity to hand. But Lehman wrote off almost $2bn on mortgage-backed securities and leveraged loans, while Goldman wrote down a billion on each.
Given that banks in aggregate are thought to be holding around $200bn of leveraged loans, which have plunged in value by around 15%, write-offs in this area could reach $30bn across the board, said Nils Pratley in The Guardian. Meanwhile, tumbling commercial property is another area of concern, as are credit card and car loans and student debt (also packaged up into securities) now that US consumers are pulling in their horns. The IMF reckons the financial system could be in for total losses of $800bn as contagion goes global. As Alex Brummer said in the Daily Mail, “you ain’t seen nothing yet”.