Tuesday the market figuratively flung itself on the floor and had a temper tantrum at the news that the Federal Reserve Bank would only cut the Fed Funds rate 25 basis point at the December Federal Open Markets Committee (FOMC) meeting. We have commented here how the Fed in recent months has appeared to encourage this type of behavior by appeasing that sort of reaction with rate cuts and promises of rate cuts. Wednesday morning the Fed announced the creation of a Term Auction Facility (TAF) and other initiatives in conjunction with the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank to address elevated pressures in short-term funding markets.
Under terms of the TAF program the Fed will “auction term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window.” The first TAF auction of $20 billion will be held Dec. 17 with a second auction of up to $20 billion on Dec. 20. Reportedly included in this collateral is the type of subprime mortgage backed securities the value of which, or lack there of, created the problem in the first place.
How will the Fed value such securities and given what we know of them, how can this be viewed as anything other than a bailout.
The market was sated and the Dow rallied more than 200 points on the news. It could not hold those gains though, dropping nearly 400 points from its high before settling slightly higher on the day.
We are not suggesting that the Fed put this together in reaction to the market, such a detailed plan takes much planning but the timing of the announcement is awfully suspicious. And it seemed to serve the purpose of satisfying those calling for more rate cuts. Remember Fed Chairman Ben Bernanke signaled the December rate move in a speech at the end of November on the same day when third quarter GDP was revised to up 4.9%. In the 1990s, such growth figures mandated a tightening.
By this point in time we know that the housing market and subprime mess equals big problems into the future but the Fed should be more forthcoming about why they are cutting rates and injecting cash into the system when unemployment figures are well below 6%–what used to be considered full employment–and with GDP at 4.9% not to mention with the Dow just off of recent all time highs. Perhaps it is those numbers that should be questioned but it is getting tiresome to hear references to some generic liquidity crisis when the reality appears to be that these banks are holding onto a lot of worthless paper waiting for it not to be worthless anymore.
