Tuesday Morning Comments

What a difference a couple of days make, especially for Bear Stearns. The vibe I am getting from the media, whether the NY Times or CNN, or others, is that everything is fine, the financials are rebounding, and the fed's move to open the discount window to Broker Deals for the first time is the panacea that we have all been waiting for. Yes, the market is up nearly 300 points today, the financials are rebounding (today), and the fed discount window move should have a positive impact. However, I find it extremely difficult to just shrug off the nearly overnight collapse of the nation's 5th largest brokerage. Clearly, there are deep seeded issues which must be addressed. Unfortunately, so much attention is being focused on the symptoms than the cause. The primary problem that must be addressed is the overuse of leverage in the financial markets. For instance, Bear Stearns was utilizing leverage 30 times it cash balance. In uncertain times, such leverage has proven deadly. Yes, the fed can pump plenty of cash into the system and keep these bank on life support, but what really has to be undertaken is significant bank reform to insure that this doesn't happen again. In the meantime, in an attempt to stoke liquidity, it is widely expected that the fed will cut rates by 3/4 of a point to a point later this afternoon. Yes, these moves are significant and by many means historic, but the key here is for the banks to regain the confidence to lend. While the fed funds rate has been reduced 2.5% since the summer, mortgages rates have moved very little, and actually moved up over the past couple of months. The spread between fed funds rates and mortgage rates has soared in that time, thanks to fear and liquidity (especially for jumbo mortgages). Should the spread narrow to historical norms, the upside economically would be very significant. In a real estate market like Manhattan, which has held up extraordinarily well, such a dip in mortgages rates, coupled with a cheap dollar would be very beneficial. So the key here as I see it, is not the actual funds rate, but the spread between the funds rate and what bank are will to lend. Hopefully the stoking of liquidity by the fed works, and soon.