Personal Finance Advice

For the second time in two weeks the stock market rallied for it largest gain in five years.  The Dow Jones surged 420 point for it’s fourth largest gain ever as blue chip financials lead the charge.

The Fed cut the benchmark fed funds rate by 75 basis points to 2.25%, it’s lowest level since December of 2004.  Over the weekend the Fed announced an emergency rate cut of 25 basis points to 3.25% in it’s lending rate to financial institutions.  It also opened up a new lending facility for securities firms and increased the term of it’s loans from 30 days to 90 days.

While it was less than what the market had been expecting it couldn’t put a damper on the relief much of Wall Street felt after Goldman Sachs and Lehman Brothers both released quarterly earnings statements that beat analyst’s estimates.  Both companies rebounded sharply on Tuesday after taking big hits to their stock values when investors began a general selloff of financial stocks after the fire sale of Bear Sterns  to JPMorgan was announced on Monday.  There was a growing fear for many investors of an imminent collapse of the other investment banks.

The companies reassured investors of their strong capital positions and that they would not meet the same fate as their rival Bear Stearns when it ran out of cash and was unable to meet it’s margin calls.  The estimated cash and short term assets for Goldman and Lehman were at $60 billion and $90 billion respectively.

While a strong rally when a rate cut is announced is nothing new, it will be interesting to see if the market will be able to maintain it’s momentum.  The effect of the rate cut on exchange rates and commodity prices may start to erode those gains in the upcoming days.

Monday saw the stock market hit a two year low, but what a difference a day makes.  Stocks surged 3 percent for their largest gain in nearly five years after the Fed announced plans for a new $200 billion securities lending program that directly infuses liquidity to twenty of the nation’s largest lenders and investment banks.

Wall Street loves this move because the Fed is offering to accept as collateral, mortgage backed securities, in exchange for Treasury securities which banks will then be able to resell on secondary markets for cash.  Basically the Fed is almost acting as a buyer of last resort, providing a market where none exists.

Whether this plan is large enough in scope remains to be seen but it is a step in the right direction.  Another positive note is that the Fed was able to coordinate this move with other central banks in Canada and Europe, who also plan to inject their banking systems with liquidity, albeit at a much smaller scale, approximately $45 billion.

This move also takes some pressure off of the Fed, whom many have been calling for an emergency rate cut ahead of their regularly scheduled meeting next week.  The futures market is predicting a 75 basis point cut after that meeting.

While this is a nice short term fix, that’s all it really is.  The Fed would prefer that banks lend each other money but right now they don’t trust one another.  The problem is no one wants to buy securitized debt. 

The whole point of securitized debt is to provide short term liquidity for an asset that is illiquid in nature, like a long term loan.  Credit markets are in shambles because banks are stuck with all this debt that they either can’t sell or if they can, at seriously discounted prices.

Wall Street enjoyed a nice four day winning streak before renewed stagflation fears sent investors scurrying.  Economic reports that were released showed that growth had stalled along with increasing signs that unemployment may be on the rise.

All eyes have to turned this week to Fed Chairman Ben S. Bernanke as he speaks to congressional hearings on the state of the economy.  He said while he doesn’t expect a return 70’s style “stagflation”, he does concede that with the continuing housing slump, some smaller banks could begin to fail.  Some analysts expect conditions in the credit markets to worsen further in the short term as lending institutions continue to write down losses.

With the dollar hitting record lows the price of energy and commodities continued to rise with oil and gold trading at record highs.  Overall consumer spending rose in the month of January but much of that can be attributable to the higher prices.  On a positive note, the weak dollar has spurred a growth in U.S. exports with the nation’s trade deficit shrinking for the first time since 2001.

Even with the specter of rising inflation and a falling dollar, many believe that the Fed will cut rates once again after it’s next scheduled meeting on March 18.  Financial markets have already priced in a half percentage point cut in futures trading.

Unless other central banks follow suit and lower their rates you can expect more downward pressure on the dollar and a rise in prices for dollar denominated commodities.