The Financial Markets and The Rest of the US Economy

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The Federal Reserve stepped in to prevent the bankruptcy of Bear Stearns and thereby protect both the financial markets and the rest of the US economy from what it thought could have been massive collateral damage. For the first time in its 85-year-old history, Bear Stearns reported losses in the last quarter of 2007; and amidst fears that the next to hit the wall would be Lehman Brothers, the Fed opted for the $30 billion bail out. The bailout, often termed as a ‘third line of defence,’ is a part of the package, which includes interest rates and tax cuts (now Fed rate is at 2.25%). Many argue that since Q4 results were bad for banking, then post the Q1 results, firms will be begging investors for fresh capital. If forecasts are to be relied upon, then there are another $50 billion of write-downs in the waiting. Marcel Theiliant (Analyst Global Economics, CREDIT SUISSE) avers, “If you think that the worst was over in Q4, then Q1 results will be a rude awakening.” In such a scenario, it will be a real challenge for the ilk’s of Lehman Brothers to raise capital. Nevertheless, the bailout package of $30 billion, followed by the rate cuts, infused in some degree of confidence in the markets.

Days later, when Lehman Brothers and Goldman announced their Q1 profit estimates, it turned out to be quite a relief. The profit estimates have been questioned; some claim that Lehman must have tinkered with the accounting method to suit its ends. The recent developments can be closely compared to the 2001 recession, wherein the S&P indices had gained close to 18% in March and April on the view that rate cuts announced by Fed would stave off a recession. Interestingly, the happiness was short lived and eventually the S&P plumetted, dropping by a whopping 42%.

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Source : IIPM Editorial, 2008

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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