Fed In Danger Of Losing Wager On Global Credit Crisis

Source : The Straits Times, Mar 18, 2008

Wrong moves made in bid to calm markets; ploy of cutting rates simply not working

THE desperate measures taken by the United States central bank to restore calm amid a growing storm in global financial markets are beginning to resemble wagers it keeps losing in a giant poker game.
As any serious poker player will tell you, never show emotion, be it jubilation or panic. That way, a weak hand might still come up trumps if no one calls your bluff.

Yet to seasoned gamblers, US Fed chairman Ben Bernanke seems to have made all the classic mistakes of a poker novice since this crisis erupted last August.

Take yesterday. Before Asian markets opened, the Fed announced an emergency cut of 0.25 percentage point in its discount rate - the rate it charges US banks for loans.

It also announced that it would lend directly to Wall Street firms in a move to ease the growing credit crunch that brought investment bank Bear Stearns to its knees last Friday.

The measures were aimed at sending a strong message, that the Fed stood ready to do whatever was needed to stop a meltdown in the global financial system.

Instead, the moves merely fuelled fears that there might be other US investment banks in danger of failing. Regional bourses hit the panic button and started selling, spooked by fears that US-based hedge funds, which may deal with these banks, would also go belly-up.

This is all a stark contrast from late August last year when Mr Bernanke seemed to hold all the trump cards, when he could calm markets by merely holding out hopes of an interest cut.

Yet even then, many experts were sceptical that flooding the economy with cheap money - as Mr Alan Greenspan had done regularly during his tenure as Fed chairman - would solve the problem.

They pointed to the problems that cutting interest rates could trigger - higher inflation, a collapsing dollar and the rapid unravelling in the massive debt taken out in yen that would accompany it.

Some even warned that a share market recovery would be a false dawn unless radical measures were taken to inject confidence into the bond market, where banks had stopped accepting mortgage securities as collateral.

These warnings went unheeded last year as Wall Street and the rest of the world resumed partying and sent shares to record highs in October, all on a misguided belief that a fresh era of easy money was about to be unleashed.

Seven months down the road, those observations now look uncannily prescient as the Fed grapples with a financial crisis of epic proportions and Wall Street digests the demise of a giant bank that had survived the Great Depression and several other recessions.

For many traders, the Fed's ploy of cutting interest rates is simply not working. One likens it to leading a dying horse to water and finding it too sick to drink.

And Bear Stearns may simply be the first of many Wall Street firms to keel over.

So rather than try to put out each fire in a contagion that now threatens to engulf the global financial system, the Fed should throw up firewalls and draw a line between what could be saved and what should be left to go under.

One reason why the credit crisis is so bad is that the bonds have to be 'marked to market'. As there is no trading at all in the bonds market, banks have to write billions of dollars worth of bonds to zero - even though the underlying loan repayments are still healthy.

The US$200 billion (S$277 billion) gamble the Fed made to jump-start frozen credit markets by allowing banks to swop top-quality mortgage-backed securities for treasury bonds for a 28-day period makes a good starting point.

More such measures will relieve the Fed of the accusation that it is creating a moral hazard by bailing out specific investment banks that deserve to be punished for creating the mess in the first place.

Local investors, meanwhile, can draw some relief from the fact that Singapore banks will be spared most of the systemic risks that come with the collapse of a major US investment bank.

Local institutions draw the bulk of their earnings from ultra-safe businesses such as home loans in Singapore, and their well-capitalised balance sheets and cash-rich deposits mean they could benefit from the new global financial order that will surely emerge from this upheaval.

If JPMorgan can pay a mere US$236 million for Bear Stearns, which used to be worth US$20 billion, imagine the other excellent investment opportunities likely to be thrown up as the US mortgage crisis snowballs.

By keeping plenty of hard cash on hand, Singapore banks stand a chance to transform themselves into regional or global banking giants if they play their cards right.