Chairman Bernanke Rises to the Occasion

On Friday, Federal Reserve Board Chairman Ben Bernanke took a courageous stand followed by by an equally resolute move. First, he acknowledged the real danger that exists to the markets due to sky-rocketing volatility (yesterday's post). He then took much needed action to shore up liquidity for more than just a day or two by lowering the discount rate 50 basis points as well as by easing banks' borrowing requirements at the Fed discount window.

C'est pas vrai, Monsieur Le Président Jean-Claude Trichet?

It should not be ignored that the Fed in its statement went out of its way to mention that they "will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets", thus giving banks, nervous about accepting sub-prime paper from the likes of Countrywide, an injection of intestinal fortitude to go along with the cash!

Chairman Bernanke weighed a doubt against a certainty - the risk of a short-term rise in inflation if he cut rates against a severe market downturn if he did not - and chose the right path.

Whilst I do not believe that this phase is over by a long shot - remember what a former Chancellor of the Exchequer, then Prime Minister, Mr.Winston Churchill said after the Battle of El Alamein, "Now, this is not the end. It is not even the beginning of the end, but it is, perhaps, the end of the beginning" - I do hope the Chairman's actions will have a calming effect. This could give the markets and their regulators the time they need to get their houses in order.

However, this one action alone will not be sufficient; we need to see, among other things, action on the issue of CDOs/CLOs - their "grading" as well as their marketing - and a return by lenders to sensible covenant structures and pricing of risk - KKR and others already are chomping at the bit to take advantage of the lower prices that the present market has delivered to them. It is imperative that the present excesses are curtailed or else we will see that Chairman Bernanke has only put off the day of reckoning.

The UK Government can give vital help by restructuring of the tax code to curtail the excessive "taper relief" non-loop-hole (it is, sad to say, the law) used by the Private Equity barons by lengthening their hold time from 2 years back to the 4 years it was before 2002 and increasing the tax rate from 10% to 20%. The other much needed reform is to grant tax relief to individual savers so as to boost the deplorable savings rate in the UK (this goes for the US, too).

These steps require Chancellor Alistair Darling to have the same strength and vision as Chairman Bernanke and strike a blow for stable growth rather than the "irrational exhuberance" we have lived with all too long. My plea is simple - Be Daring, Darling, Carpe Diem!

Cassandra


Federal Reserve Statements - Friday 17 August 2007

Policy Statement
Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.

Federal Funds Rate Statement
To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco.