Praise the Lord, the Fed is not asleep and the kidney stone, at least temporarily, has passed. Directly or indirectly, Jim Cramer’s meltdown on CNBC two weeks ago has born fruit. Early last Friday morning, nearly two weeks after his rant, Jim observed the 800 point drop in the Japanese stock market Thursday, possibly brought about by the collapse of the Japanese carry trade and was stunned. He realized that this event could have had a profound impact upon the U.S. economy and have easily brought about a 1,000 point decline in the Dow. Confidence in the American financial system was shaken. He felt that had the Fed not responded to this threat it might have brought about a serious decline in the American financial system, and I think he would have been right.
Japan’s interest rates the last few years have been so low, that it was common practice to borrow money in Japan, at approximately 1% and then buy secure short term U.S. bonds at approximately 4.00% and profit from the difference. However, with the collapse of the stock market and the drop in treasury yields because of the exit from equities to bonds, this ready access to huge profits has dried up and the carry trade had all but died. The pumping of money into the United States financial system was drying up. The Fed’s action Friday morning has forestalled this event. Prior to the Feds action the situation was:
A. Real estate values in the U.S. had declined precipitously.
B. The sub prime madness had all but eliminated folks with less than desirable credit scores getting loans.
C. Financing had become virtually unobtainable even for people with excellent credit scores; the jumbo loan rate (home loans over $417,000) climbed from 6.88% to 8.00% for people with excellent credit scores. .
D. Corporations, businesses, auto dealerships etc. were having difficulty obtaining
short and long term financing.
E. The stock market was in a tailspin and yields on U.S. backed bonds were declining precipitously.
F. Money, the fuel that drives business, was becoming unobtainable.
With the easing of the discount rate, from 6.25% to 5.75%, and the active encouragement by the Fed to take advantage of these funds, the risk has been diminished and liquidity has been restored. This essentially saved Countrywide Financial, the largest mortgage company in America, from bankruptcy. It will be interesting to see what happens this week and see how effective this change has been. It seems all but certain that the Fed is prepared to step in with a Fed Funds rate cut as well.
As the old saying goes,” May you be blessed by living in interesting times.”