Thursday, 20 March 2008


Its interesting to follow the concerted moves by the US Federal Reserve using different measures, monetary as well as the policy measures to combat the spreading sub prime problem. Its a gripping battle. Though I dont understand much of it , its gripping all the same to read about the battle thats on.

When first Ben Bernanke cut the the overnight window rate in last September (2007) it almost went unnoticed, except for the huge upswings in the Indian equity markets and some mumblings in the background about recession , slow down etc, largely it was accepted as a matter of routine monetary policy. Then followed a series of aggressive rate cuts finally resulting in a total of 3% cut in just under 6 months, which is phenomenal by any monetary policy standards.

Even till recently the desperation in the rate cuts were not understood properly, not only by the world but in the US too. This is evident from the statement by President Bush that one (read FED) should not over react.

That was before Bear Stearns caved in.

Until then subprime was yet another new topic of financial management. Reaction and over reaction was a matter of opinion.

The overnight caving in and the subsequent Fed orchestrated (and $30bn guarantee too) buy out , albeit at dirt cheap price, of Bear Stearns by JP Morgan heightened the public sensitivity to the subprime issue. Dramatically instead of cautioning against over reaction, the clamour for aggressive rate cuts was more audible. The sub prime "problem" in the public opinion had become "crisis".
The quick , clean and crisp handling of Bear Stearns issue brought to highlight the maturity of the US financial system a well as the preparedness of the US FED.

The FED was not stopping at that. They had an action plan. A plan for an onslaught on the demon of subprime crisis and also simultaneaously to spur the economy out of a possible recession. It came out with a $168 bn action plan , with a multi pronged approach and not just monetary policy measures, a part of which was used for the JP Morgan take over of Bear Stearns.
One of the recent measures the FED came up with was the capital reduction of the govt. sponsored housing companies, Fannie Mae & Freddie Mac, from $30 bn to $20bn. The measure is expected to inject an additional $200bn in to the US housing loan market. The plan will assist new home buyers to take up loan (read decrease in non-saleability of US home loan foreclosure auctions) and existing home loan owners to refinance using cheaper motgagaes (read better repayment leading to better saleability of Mortgage Backed Securities).
A few other measures have been initiated as part of the package deal in combating the subprime crisis. The temporary cap on mortgages the company (Fannie & Freddie) can purchase or guaratee in high cost markets have been increased from around $0.42 mn to around $0.75 mn. Also the combined cap on mortgages for both the companies put togather which was at $1.5 trillion has been lifted.
The FED by these measures is trying to induce liquidity in the US housing loan market which has almost but dried up. The measures are not a day early, and as for the US financial institutions we all hope it may be just enough to help them start their climb back to the edge of the subprime pit.
As for the present US FED and Ben Bernanke , the evidence is out that they have emerged from the shadows of the Greenspan era and cut a path for themselves in the books of financial history.

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