Fed Moves To Calm Investor Panic

Fed Moves To Calm Investor Panic
Evelyn M. Rusli, 21 August 2007, 6:00 PM ET

The Fed moved to soothe the savage Wall Street beast on Tuesday.

Droves of wary investors fled risky investments and not-so-risky investments for the safe haven of Treasury bills on Tuesday morning. To quell the stampede, the New York Fed slashed a fee bond dealers pay to borrow Treasuries to 0.5% from 1.0% during afternoon trading. By lowering the borrowing cost, the Fed made Treasury bills easier for banks to acquire, helping to satiate frenzied demand for these securities.

Before the Fed action, the yield on the three-month Treasury bill had plunged to 2.93% in morning trading, the first time it was below 3% in two years. Investors were exhibiting a lack of confidence in commercial paper, the mainstay of money-market funds and one of the safest private-sector investments. These short-term loans to corporations are trading at about 5.34% for three-month maturities, far above the slightly safer T-bill rate. After the Fed acted, the three-month Treasuries rebounded to 3.64%, up from 3.18% late on Monday.

The recent exodus from bond-market investments with practically any risk underscores a systemic trust crisis plaguing U.S. markets. The credit crunch that arose from the meltdown in the subprime mortgage market has hit a swath of financial institutions hard and fast, leaving investors with sky-high losses. As the hemorrhaging continues, investors have grown leery of the banks, the rating agencies, mortgage players, and even the Federal Reserve itself.

"The public has lost confidence in the integrity of investment and mortgage bankers," University of Maryland Business Professor Peter Morici said on Tuesday. "A lot of people with conflicting interests exaggerated the quality of the paper they were selling."

Mortgage-backed securities created from loans to borrowers with limited creditworthiness were treated as relatively safe investments by the ratings agencies and financial firms that packaged the bonds in the past few years. Early this year, when some borrowers began defaulting on their loans and housing prices started to fall -- meaning that the homeowners couldn't sell their homes at profits to pay off their debts -- investors began fleeing subprime-backed securities and then all kinds of mortgage-backed bonds.

In this era of skepticism, investors have rushed to place cash in the safest vehicles. Suddenly, low-yielding but highly dependable government bonds look like a hot investment. On Tuesday, yields across the Treasury maturity spectrum extended their recent tumble. The return on the six-month bill fell to 3.79% on Tuesday from 3.89% on Monday, while the benchmark 10-year note dropped to 4.60% from 4.63%. But the most notable decline was the three-month issue at 2.93%, down from 3.18% on Monday and around 4.80% a month ago.(See: "Wall Street Sidelined By Flight To T-Bills." )

Read full article here