The Fed lowered the Discount Rate, but not the Federal Funds Rate, by one half percent. This was a bank bailout, and the timing was coincident with options expiration date in order to bailout options writers who were about to get their clocks cleaned. They needed a huge rally and they got one, albeit the rally was insufficient to fully cover these derivatives positions. What the Fed is saying, is they want banks to borrow money from them aggressively, however, they don't particularly want individuals to borrow more. This is a bank bailout, whereby large financial institutions who are holding depreciated mortgage backed securities suffering from the subprime and spreading prime loan mess can now access dollar denominated cash cheaper. But it is something else. It is a green light for banks to borrow directly from the Fed without the normal scrutiny borrowing from the Fed entails. Financial Institutions cannot sell much of their mortgage backed securities to raise cash because the loss they would take is prohibitive. They are stuck holding the old maid card. They can play games to some extent on the value these deteriorating securities hold on the books, however to exchange them for cash is a reality check. They are worth substantially less than what they paid for them, as underlying mortgages default on payments. This is a liquidity rescue of financial institutions. A bank bailout.
There are a lot of problems in the economy right now. The subprime and spreading prime mortgage situation is just one. That will get worse next year as more of these marginal mortgage loans reset to much higher interest rates (higher mortgage payments) as the teaser periods, typically the first one to three years of the mortgage, give way to the final 27 to 29 years of interest rates reset at a higher than normal rate than had they grabbed a fixed rate to begin with. And that is where the problem lies for consumers. Many of theses teasers were obtained with the idea that the property would be flipped at a profit, under the assumption the property would rise in value. However, property values are falling, thus mortgages are in many cases greater than the properties are worth, ergo, property owners are stuck. If they default, we are talking foreclosures. Pass through payments to securities holders fail, and the underlying holders of packaged mortgages end up with securities deteriorating sharply in value.
Another problem brewing here is the latest stock market plunge. The Wilshire 5000 index is essentially an index of all of the stocks listed on the NYSE, NASDAQ, and AMEX exchanges. At one point Thursday, August 16th, it had dropped from 15700 ($15.7 trillion) to 13800 ($13.8 trillion). This means the stock market had experienced a loss of $1.9 trillion in one month. In other words, the stock market saw 1.9 trillion of wealth wiped out in the past month. Some of that has been recouped the past day, however this decline is expected to continue for several months, so the damage could get much worse. This will no doubt trickle through to the economy. The loss this weekend sits at $1.2 trillion.
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