Wall Street's ecstasy over the Federal Reserve's plan to lend $200 billion of Treasury securities in exchange for a variety of mortgage-backed bonds reverted to caution. A day after the biggest rally in more than five years, the stock market pulled back.
And some parts of the credit markets showed skepticism about the Fed's move, too, despite hopes that it will provide a short-term salve to some of the margin-call issues that have hindered the normal functioning of the financial markets lately.
Though major stock indexes posted modest gains throughout much of the day, share prices swooned toward the end of the session as oil prices jumped to about $110 a barrel. The Dow Jones Industrial Average slid 46.57 points, or 0.4%, to 12110.24. The Standard & Poor's 500-stock index slipped 0.9%, or 11.88, to 1308.77, hurt by a 2.3% decline in its financial sector. The Nasdaq Composite Index fell 0.5%, or 11.89, to 2243.87.
Crude prices rose despite government data showing a rise in U.S. stockpiles of oil. Analysts said the lack of response to the inventory data underscored the extent to which crude is being driven for now by speculators interested only in financial bets.
The Fed's move didn't help the dollar, which fell against most other major currencies. The greenback sank to another record low against the euro.
In the bond market, traders realized what the Fed's rescue bid won't do: solve the problem of declining house prices, which is likely to continue for a good while longer.
"The ultimate fix would be finding a way to stop home prices from creating losses for the banking system," says James Bianco, president of Bianco Research.
Two-year and 10-year Treasury notes rallied as doubts emerged about how far the Fed's move will go. The two-year note was up 6/32 to yield 1.635%, while the benchmark 10-year was up 31/32 to yield 3.481%.
The yield on five-year inflation-protected securities, called TIPS, fell back to negative territory to yield -0.13% after hitting positive ground Tuesday. This suggests the markets snapped back to feeling more concern about liquidity and the economy. TIPS are essentially the only security to protect broadly against declining purchasing power.
"We're seeing some old problems continue to haunt the market today," said Peter Cardillo, chief market economist at Avalon Partners, referring to investor uncertainty over how the long-term credit crisis will end and how much of an effect it will have on the broader economy.
As home prices decline amid a burgeoning recession, the value of mortgages and mortgage-backed securities has fallen. Banks, investors like hedge funds and securities dealers that hold mortgage-backed securities either as investments or as collateral for loans have sustained sizable losses as a result.
The risk premiums on mortgage-backed securities compared with five-year Treasurys has fallen to 3.02 percentage points from 3.48 last Thursday -- among the highest since the 1980s. This could soon translate into lower mortgage rates for consumers.
"Fundamentally, mortgages are still cheap," said Arthur Frank, head of mortgage-backed-securities research at Deutsche Bank Securities in New York. "The Fed action [Tuesday] certainly helps the market a lot, but nothing guarantees we might not see spreads widen again."
Banks and dealers alone have taken at least $140 billion of write-downs to account mostly for these declines. They face pressure to obtain more capital to buttress their balance sheets, and this has led many lenders to demand more money from clients and borrowers in return for their loans. This led to margin calls like the one that caused Carlyle Capital Corp. to sell high-quality assets to attempt to meet demands.
The credit markets, and particularly the mortgage-backed-securities markets, have reacted positively to the Fed's move thus far, though observers note this is a temporary patch. The Fed may renew its lending arrangement after a 28-day period, but one day down the road, the dealers that tap this facility will have to take their collateral back.
source: p.C1 12mar2008
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