Global markets collapsed as news spread about the Bear Stearns collapse.The Fed acted swiftly. First it engineered a buyout of Bear Stearns by JP Morgan Chase, and then it went ahead and cut interest rates by 75 basis points.It also took some unprecedented steps to pump liquidity into the system.It allowed financial institutions other than commercial banks to approach it directly for loans.Further, more importantly it will be advancing loans against those very illiquid securities which have triggered the present crisis. In the latest such move, the Office of Federal Housing Enterprise Oversight , or OFHEO has reduced the amount of capital it requires Fannie Mae and Freddie Mac to maintain on their balance sheets. By reducing the capital surplus level from 30% to 20% an additional $200 billion will be released in the mortgage backed securities market.
These measures led to the dollar rebounding from record lows, and commodities from oil to wheat falling from record highs. Stocks rallied, dipped and then climbed again.Most analysts expect the rally to continue. Meanwhile rates on fixed mortgages also dropped sharply. The rate on a 30 year loan dropped to an average of 5.87% from 6.13% a week ago, and a 15 year mortgage to 5.27% from 5.60%, reflecting renewed confidence in the mortgage market.
The reason is simple. With most people having accepted that we are already in a recession, any bit of decent news leads to short covering in a heavily oversold market. The sectoral bad news regarding housing and financial firms has already been factored in. The only thing spooking the markets is the possibility of another Bear Stearns lurking out there. There is also the feeling that financial firms may be reluctant to approach the Fed for fear that doing so will be taken as a sign that they are in trouble.All this will lead to nervousness in the markets for the next 2 or 3 months, and then things will surely improve.