Don’s Outlook 9/17/08
Stocks managed to gain ground yesterday as investors looked ahead to a federal bailout for troubled insurer American International Group. The Dow Jones Industrial Average finished up 142 points, or 1.3 percent, closing at 11,059. Shares of AIG swung wildly on enormous volume of 1 billion shares as rumors of a government rescue plan worked their way through the market. The S&P 500 gained 1.8 percent to finish at 1,214, and the Nasdaq Composite Index advanced 2.3 percent, ending the session at 2,208. The $85 billion rescue plan for AIG finally came through after the market had closed.
Fed watchers, for once, were divided on what Federal Reserve Chairman Ben Bernanke and his colleagues would do yesterday when they met to set interest rate policy. The central bank ultimately decided to leave the federal funds rate unchanged at 2.0 percent in the first unanimous decision of the year. The Fed’s restrained statement—it made passing mention of “strain” in the financial system—was belied by its actions throughout the day. The Fed and its district bank in New York flooded the banking system with nearly $100 billion in cash to keep things moving.
Central banks around the globe followed suit. The European Central Bank alone injected $100 billion worth of euros into the 15-nation eurozone in order to maintain suitable liquidity conditions. These drastic infusions were necessary in the wake of Monday’s global stock sell-off and the evaporation of almost all excess cash in the world’s capital markets. In the U.S., the federal funds rate—the interest on interbank overnight loans—soared to 6.5 percent as financial institutions began losing confidence that even these brief, 12-hour loans would be repaid. The Federal Reserve’s target for these loans is 2 percent.
Despite the government’s unprecedented intervention in the private (and quasi-private, in the case of Fannie Mae and Freddie Mac) over the past several months, investors are still wary. Stocks fell in early trading today as the Commerce Department reported that new home construction plunged 6.2 percent in August, to the slowest pace since the recession-plagued days of the early 1990’s. The current financial crisis, of course, has its roots in the U.S. residential real estate market, which entered what most economists now agree was a “bubble” phase in the late 1990’s, when home prices spiked far above their long-term average rates of growth. When that bubble burst earlier this decade, the giant mortgage-backed securities market that had been built around it also began to crumble.
One bright spot amid the wreckage on Wall Street has been the price of oil, which continues to slide, falling below the $100-per-barrel threshold on Monday for the first time in 6 months. Energy traders are betting that the current financial crisis could ripple out into the broader economy and decrease petroleum demand in the coming months. Helped by the slide in oil prices, the closely-followed consumer price index fell 0.1 percent in August, the first time in two years the gauge of retail prices has showed a decline. The core CPI, which strips out food and energy costs, rose 0.2 percent. Look for inflation to decline further in the coming months.
Today’s focus of investor anxiety is Washington Mutual, the giant thrift that is also one of the largest mortgage originators in the U.S. The Associated Press reports that federal regulators have been quietly pressing healthier private banks to throw Washington Mutual a lifeline. Shares of Morgan Stanley and Goldman Sachs, the only remaining independent Wall Street firms, are also trading sharply lower today as investors speculate on what the future holds for the storied firms. Both Morgan Stanley and Goldman Sachs posted quarterly profits earlier this week.
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