Fed Man Says: STOP!

Bank Stocks Rally on Fed Move
Tuesday March 11, 11:23 am ET
By Dan Seymour, AP Business Writer

Bank Stocks Rally As Fed Offers to Swap Super-Safe Treasury Bonds for Mortgage Debt

NEW YORK (AP) -- Bank stocks spiked Tuesday after the Federal Reserve offered to swap $200 billion of ultra-safe Treasury bonds for some of the troubled investments roiling Wall Street.

The offer is designed to make it easier for banks to raise cash. By temporarily trading no-risk Treasurys for mortgage bonds that have become toxic on Wall Street, the Fed is giving banks collateral they can use to borrow money.

Over the last few months, lenders have developed a distaste for risk and uncertainty, and numerous markets where banks typically raise cash have frozen up. It is easy to borrow money using Treasury debt as collateral because the U.S. government is considered the most creditworthy borrower in the world.

"It takes a lot of the pressure off the short-term funding side of the major brokers," said Sanford Bernstein analyst Brad Hintz, who used to be chief financial officer of Lehman Brothers Holdings Inc. "What the Fed is doing is attempting to break the back of uncertainty in the repo market and ensure that no major financial institution goes down."

Hintz said a bank failure today would be far more problematic than it would have been 20 years ago. Through a complex series of contracts and swaps, Wall Street has created a nexus of interconnected risk, he said. The Fed needs to ensure no banks go bankrupt because they are so dependent on one another, he said.

Shares of investment banks, which were clobbered by a seizure in certain corners of the bond market Monday, recovered much of their value Tuesday.

Lehman Brothers climbed almost 7 percent, while Morgan Stanley, Goldman Sachs Group Inc., JPMorgan Chase & Co., Merrill Lynch & Co., and Citigroup Inc. all spiked more than 4 percent.

The Philadelphia Stock Exchange KBW Bank Index, which tracks 24 banks and lenders, surged nearly 5 percent. The dollar jumped, and "safe havens" such as gold and Treasury bonds, which investors have been flocking to in order to shelter their investments from the credit crisis, posted declines that have been rare in 2008.

Douglas Peta, market strategist at J. & W. Seligman & Co., said he is not convinced the money banks borrow will be put to good use.

Banks are struggling, and Peta said rather than lending the capital they raise the companies may use it to bolster their own balance sheets. This is good for the companies themselves, he said, but would not help financial markets.

"That's the equivalent of taking money and stuffing it under the mattress," he said. "What we're looking for is money to be lent."

The Fed has tried to stem the sell-off of a range of debt, particularly home loans, by cutting interest rates.

This approach has not worked, said LibertyView Capital Management President Rick Meckler, because companies that are borrowing at lower interest rates are still not using it to buy risky investments.

Despite lower interest rates, many lenders are still under pressure to dump their investments to buttress their finances or repay their own lenders. This selling has yanked down prices for many kinds of investments, he said, which in turn forced more selling.

Meckler said by coming up with more creative ways to inject liquidity into financial markets, the Fed will hopefully relieve some of the pressure on lenders to sell their assets.

"You were really in a vicious cycle," he said. "This is an attempt to break that cycle."