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Fed Helps Money Markets As Credit Stabilizes

At long last the mechanics of the global financial markets seem to be returning to something approaching normal.

Investors are starting to buy and sell stocks based on fundamentals — like earnings — and the credit markets are showing signs of a thaw. While the economy and the financial sector are far from out of the woods, there are some signs that trust is returning, something that has been in short supply in recent weeks.

Treasury Secretary Henry Paulson took a victory lap of sorts on the floor of the New York Stock Exchange on Tuesday, shaking hands with traders. He said that he thought the administration's moves to right the financial markets were starting to work. He wasn't greeted as a hero at the NYSE. Instead traders extended their hands to be shaken, but they seemed more interested in executing their trades than glad-handing the man who has tried to manage the worst financial crisis since the Great Depression.

If there is optimism on Wall Street, it is of the cautious variety. The Dow Jones industrial average closed down 231 points at 9,033. And the London Interbank Offered Rate, known as LIBOR, a key barometer on lending, dropped 3 basis points to 4.96 percent Tuesday, the British Bankers' Association said. That's the lowest level in a month. LIBOR is the rate at which U.K. banks lend each other money, and it has been skyrocketing during this crisis. LIBOR is important because it is used to determine rates on some $360 trillion in mortgages, company loans and derivatives.

Closer to home, the price of three-month Treasury bills has also fallen for the fourth consecutive day. That's an indication investor panic is mellowing because they are no longer fleeing into the arms of government debt. At one point during the crisis interest rates were so low that investors were virtually paying the Treasury to take their money. The yield on Treasury bills rose to 1.22 percent on Tuesday, its highest level in about a month.

Another good indicator: the so-called TED spread. That's the difference between what banks and the U.S. Treasury pay to borrow money for three months. It has also declined. It was 261 basis points Tuesday, down from 298 basis points Monday, according to Bloomberg figures.

Amid those encouraging signs, the Fed unveiled new details about its money market facility. The central bank said in a statement that it was prepared to lend as much as $540 billion to money market mutual funds that are having liquidity problems. Money market funds got socked earlier this month when some panicking investors had tried to take their money out of the funds all at once.

The funds had trouble selling assets quickly enough to cover those redemptions. The Fed's new facility is meant to be a backstop so that doesn't happen again. Banking giant JPMorgan Chase will be managing the new program for the Fed. JPMorgan Chase and the Fed will be allowed to buy certificates of deposit, bank notes and short-term commercial paper. The new Fed facility is temporary; it will be in place until April 30 unless the Fed sees a reason to extend it.

Some Wall Street insiders were concerned about some of the provisions of the Fed plan. For example, the Fed is only going to buy 90 percent of any assets the money market funds want to sell and pay with cash. The other 10 percent would be in asset-backed commercial paper. But David Glocke at the Vanguard Group says he doesn't see that as a problem. He thinks the plan offers tremendous liquidity to the money funds, and the system has been in dire need of that

Bracing for Bad News

While there are signs that the government's programs are starting to work, investors are still bracing for bad news. Specifically, they are expecting the fallout from the past couple of weeks to start showing up in earnings reports and economic data. When the level of that damage comes to light, it could spook investors anew. Whether it is companies that have had trouble financing, hedge funds caught on the wrong side of mortgage-backed securities or even just economic reports — they all have the potential of unnerving investors all over again.

A survey of more than 1,000 financial professionals attending the annual conference of the Association for Financial Professionals showed that they thought government actions over the past three weeks have managed to stabilize the credit markets.

"While the economy appears to be shaken, credit looks to be stabilizing," Jim Kaitz, president of the association said in a statement. "More than three weeks ago, we said that the most pressing issue for business is access to credit. Actions by policymakers have in recent days brought some measure of confidence back to the markets."

The financial professionals surveyed also agreed that the economy is already in recession. Ninety-seven percent said they believed it had already starting contracting. A third of those surveyed said that the recent turmoil in the credit markets is what precipitated the recession. Two-thirds of those asked said the U.S. was in recession before the financial institutions imploded in September.

More Financial Fixes

Eugene Ludwig, a former comptroller of the currency and an adviser to Barack Obama, was on CNBC this morning offering his own prescriptions for what should happen next to prevent the financial crisis from collecting more casualties.

"We need to focus on the homeowners and start rebuilding the economy," Ludwig said, adding that he has heard some 10,000 homeowners are being thrown out of their homes each day. "They were sold products by unregulated institutions; they thought they were buying one thing when they were getting another. ... We have to have a comprehensive program. What we have today is a number of well-meaning Band-Aids."

Rep. Barney Frank of Massachusetts, the chairman of the House Financial Services Committee, is holding hearings aimed at sketching out the parameters of a new plan that could stimulate the economy and help homeowners. He told CNBC Monday afternoon that the plan would need to be larger than 1 percent of GDP. While some analysts had discussed a $150 billion stimulus plan, he says the package will have to be much bigger than that. The talk on Capitol Hill is that it is more likely to be in the $300 billion range.

"If we do not do this kind of stimulus, the deficit will get worse because of the loss of economic activity," Frank told CNBC when asked whether this kind of spending will just blow a hole in the already ballooning deficit. Speaking broadly, Frank said he envisioned a plan that would include some sort of relief to states, money for infrastructure projects that are already on the drawing board, and middle-class tax relief.

Democrats in Congress have been agitating for a new stimulus. The Bush administration had been lukewarm to such a plan until Monday, after Fed Chairman Ben Bernanke told a House committee that he thought a stimulus plan was a good idea.

"If the Congress proceeds with a fiscal package, it should consider including measures to help improve access to credit by consumers, homebuyers, businesses and other borrowers," Bernanke said. "Such actions might be particularly effective at promoting economic growth and job creation."

The Fed has already tried to goose economic growth by lowering interest rates. On Oct. 8, as part of an unprecedented global cut, the Fed dropped the overnight federal funds rate — the interest rate at which banks lend to each other — to 1.5 percent from 2 percent. Wall Street investors are expecting another rate cut when the Fed's Federal Open Market Committee meets in Washington on Oct. 28-29.

In making his case, the Fed chief provided a gloomy recitation of economic woes that have already occurred. The economy shed 168,000 jobs in September, bringing the total job loss since January to nearly 900,000. That means unemployment has risen 1 or 2 percentage points since January. Bernanke said the housing market is also depressed. Single-family-housing starts dropped 12 percent in September.

"Residential construction is likely to continue to contract next year," Bernanke said.

In recent years, Fed chiefs have been focused on narrowing the budget deficit. So Bernanke's support of more spending is unusual. And while he conceded that there were trade-offs in spending more government money and adding to the debt, he said he still supported a package to help spark economic growth.

"With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Bernanke said.

There has already been a stimulus package from Congress this year. It enacted a $168 billion plan that included tax rebates for individuals and tax breaks for businesses last spring. There were rebate checks of up to $600 per person that gave the economy a boost, but not enough to see the economy through the current difficulties associated with the financial crisis.

NPR's Chris Arnold contributed to this report.

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