The Federal Reserve’s unexpected reduction in the discount rate it charges banks for short-term loans triggered a rally in stock prices Friday.
Whether that action proves a Band-Aid or a suture on markets that have bled losses since late July will be tested early this week.
“I believe it is a good step, but too soon to know if it will completely stabilize the financial markets,” said Bob Bush, founder of Eric Forecasting, an economic and fixed-income advisory service in Englewood.
Stock markets may rally, but they are following moves in the debt markets, where half the mortgage securitization business has evaporated and short-term interest rates have skyrocketed as money becomes harder to find.
Boulder mortgage banker Lou Barnes was skeptical of the Fed’s move, arguing it doesn’t address the fundamental problem – the market’s inability to value the mortgage-backed securities made in recent years.
Of the $11 trillion in outstanding mortgage debt, about $4 trillion has suffered significant losses in value, he estimates.
Government regulators need to do something innovative – perhaps re-underwrite the problem loans to stricter government guidelines or resurrect an equivalent of the old Resolution Trust Corp. to buy and remarket the bad debt.
“Two weeks of Fed Band-Aids have burned precious time,” he said.
Others argue that the move was just what the markets needed to recover and move higher.
Jim Cramer, the CNBC commentator who two weeks ago blasted Fed officials as “nuts” for not lowering rates, told his viewers that 14,500 was ahead for the Dow Jones industrial average.
Spooked investors pulled a record $19.9 billion from equity mutual funds in the week ended Aug. 15, more money than they took out in the days after the Sept. 11, 2001, terrorist attacks, according to liquidity research firm Trim Tabs Investment Research.
Friday’s rally needs to hold this week or it could create a crisis of confidence that damages the larger economy, said University of Maryland professor Peter Morici.
“This should give markets a lift … but will it stick on Monday and Tuesday? If not, we are in much bigger trouble than economists have conceded so far,” he warned.
Staff writer Aldo Svaldi can be reached at 303-954-1410 or asvaldi@denverpost.com.
