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August 17, 2007

Relief is Spelt B-E-N
by Brady Willett

Yen carry is blowing up, global stock prices are in mini-crash mode, and the financial meltdown is threatening to spark an economic meltdown. Having gingerly danced with rhetoric and liquidity injections in recent days, the Fed started to boogie this morning. Here is the statement in its entirety:

To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. The Board is also announcing a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. These changes will remain in place until the Federal Reserve determines that market liquidity has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding. The Federal Reserve will continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York and San Francisco.

The initial response to this move is, obviously, relief: financial market participants were - literally - screaming for help, and the Fed is now on the job. But after the initial rebound in the markets what will happen in the coming months is considerably less clear. Will today's actions and any follow up actions be enough to stabilize bearish spirits?

Those quick to answer 'no way!' should recall that bears have been wrong about impending doom countless times in recent years. Perhaps this is just another bear trap that leads to the mother of all short covering rallies? Conversely, to treat emergency Fed help as a reason for optimism may be equally or even more foolish. After all, the credit problems that have taken many years to develop are not going to vanish simply because Bernanke has learned the Greenspan Two-Step. For the record, Greenspan began his emergency moves in early 2001 and things did not stabilize until early 2003. Stay tuned...

Brady Willett
FallStreet.com