The Federal Reserve lowered its key Funds Rate by 0.75%. Most had expected a full 1% cut, but markets rallied, with the Dow posting a 420-point gain on the day.

The Fed has been very busy lately. In addition to backing JP Morgan’s buyout of Bear Stearns, the central bank has allowed securities broker dealers to access Federal Reserve lending through the discount rate. Traditionally reserved for banks only, the move is an unprecedented attempt to prevent what happened at Bear Stearns from happening with other brokers.

What happened at Bear Stearns, according to CEO Alan Schwarz, was similar to a classic bank run. The firm simply did not have the cash to continue honoring redemptions and withdrawals at the rate they were happening.
The Fed’s move to back brokers in similar straits is a risky one for the central bank, as it’s putting up its own assets and, should there be a run on banks, it might be a run on the Fed.

Bear Stearns’ investor relations page says it all:

“Never an unprofitable year—Bear Stearns’ primary emphasis is on creating long-term value for shareholders.”

“83 Years of Profitability.”

All it took was one bad year for the house of cards to collapse.

It will likely be years before we know how deeply the sub-prime crisis affected Bear’s balance sheet. Exactly how devalued are its derivative holdings, and what, if anything other than a very established and reputable brand, is JP Morgan buying?

One thing is certain: giants are falling, and it’s best to get out of the way when that’s happening.

Disclosure: sold SKF (ProShares Ultrashort Financials) Friday 3/14. Oops.

On the heels of the Fed’s bailout of Bear Stearns, JP Morgan Chase said Sunday that it has agreed to acquire Bear Stearns for $2 per share.

According to Reuters, Bear Stearns will remain open for business and the move was made to prevent a “fire sale” of Bear Stearns assets. Exactly what price would constitute a fire sale is unclear, as $2 per share seems pretty low for a company that was trading most recently at $30, and just Thursday at around $57. One year ago, the stock was hovering at around $150.

MarketWatch is reporting that the Federal Reserve will back approximately $30 billion of Bear Stearns’ less liquid assets, as agreed to on Friday.

This will likely have a deleterious affect on markets worldwide, as it is clear by the disconnect between Friday’s closing price and the final sale price that markets have not fully appreciated the amount of bad debt accumulated by financial institutions.

The Federal Reserve reported that its March 10 Term Auction Facility Auction resulted in $50 billion in loans at a rate of 2.80%.

Importantly, the bid-to-cover ratio was 1.85, meaning that there was nearly a two-to-one ratio of requests for funding to actual loans. 82 banks participated, and there is no way to know what banks were involved.

Recent history shows that these funds will go toward shoring up the balance sheets of banks in trouble, rather than being passed on to consumers and businesses originating new loans. Banks’ balance sheets are starting to look like a black hole of bad paper, and there’s no telling how large that black hole is. We can be reasonably sure it’s larger than $92 billion, though.

The Federal Reserve approved an arrangement between JP Morgan Chase and Bear Stearns that provides short-term financing to Bear Stearns due to liquidity concerns. In a statement Friday, the Fed added, “The Federal Reserve is monitoring market developments closely and will continue to provide liquidity as necessary to promote the orderly functioning of the financial system.”

All major indices were down, and Bear Stearns stock plummeted 40% on the news.

Stearns executives said major investors withdrew funds at a pace that threatened the company’s liquidity, though withdrawals have slowed down since announcing the emergency funding.

Marketwatch had an interesting story on this, noting that J.P. Morgan himself rallied other banks to bail out banks and trusts that had made bad investments in 1907.

Bear Stearns executives brushed off criticism in December, implying that the worst of the sub-prime mortgage crisis was behind them, after the company posted its first loss in 80 years. The fallout of the sub-prime mortgage crisis, however, has yet to be measured. Other investments are being affected, creating a liquidity crisis for major banks.

The Federal Reserve published its consumer credit report today, revealing that consumer debt increased at an annualized rate of 3.3% in January, to 2.5245 trillion dollars, an increase of 6.9 billion dollars over December 2007.

Non-revolving debt, such as mortgages, increased by only 1.1% annualized, while revolving debt such as credit card debt increased by 7% on an annualized basis ($5.6 billion).

The Dow Jones Industrial Average closed below its January low of 12,000 and all Major U.S. stock indices closed lower than they have in over seventeen months.
The S&P 500 closed the day at 1,293, its lowest level since August 2006. The Dow closed at 11,893, its lowest close since October 2006. The Nasdaq, at 2,212, closed at its lowest level since September 2006.

Capital preservation and risk management are the keys to successfully navigating these choppy waters.

The S&P 500 closed at 1304 today, below its January 22 low of 1310. For day traders and momentum traders, this is a major indicator that the index is headed lower in the near term. The intraday low of 1270 on January 23 remains intact, but heavy selling marked the day right into the closing bell.
The Dow Jones Industrial Average, at 12,040, remains slightly above its January closing low of 12,000.

The S&P’s close is a strong indicator that this bear market is not through with us yet, and economic indicators show no sign of improving.

The Federal Reserve Board of Governers today announced that the key Fed Funds Rate would be dropped to 4.50%, the second rate cut since the beginning of the summer.

Critics are claiming that the Fed is throwing caution to the wind when it comes to inflation and a possible recession, instead favoring the ailing financial services sector. It remains to be seen, however, whether this rate cut will stabilize the financial services sector, which has written down tens of billions in recent months due to risky sub-prime lending practices.

It’s likely that this rate cut will slow down, rather than alleviate, the trouble banks are encountering. Some of the major players, including Lehman Brothers, have not yet reported on August and September’s weaknesses.

Recent volatility in the market suggests that there is no end in sight, as no one really knows how much of the asset-backed commercial paper out there is worthless. Further, derivative instruments such as CDOs and SIVs complicate the issue by spreading the damage done by loose lending.

After a tumultuous week that saw two sharp dips in the Shanghai Index, Tuesday saw the market end in positive territory, after being down 7% earlier in the trading day.

What gives?

Investors in China and other emerging markets should be aware that these are high-risk investments, and therefore will experience higher volatility than investments in the more mature markets of Western Europe, North America, and Japan.
The recent dips experienced in Shanghai are the direct result of a change in China’s taxes on stock investments. The change was implemented to detract speculators from high-risk short-term investments. It is the first step in the maturity of China’s Finance Ministry, which is implementing long-term solutions to the rapid business development issues the country is facing.

Though it is likely that highly volatile days like the ones we have seen will happen again in China, the long-term trend should remain positive, as its development is just underway.