Sunday, August 19, 2007

Summer Close Out Sale

As we prepare for the last two weeks of August and the Labor Day Holiday, traditionally a time of vacation, low volume and low volatility on Wall Street, there are many folks who hope the Fed move on Thursday was the right prescription for the credit markets. By dusting off a little used weapon in the monetary policy arsenal, Mr Bernanke has attempted to encourage banks to loan to the credit worthy, without bailing out those who have been irresponsible in the use of leverage. By lowering the discount rate by half a percentage point to 5.75%, the Fed lowered the rate it charges banks when they borrow from the Federal Reserve. While borrowing from the Fed is viewed by banks as the creditor of last resort, this should help companies such as Countrywide, which has a banking operation and is able to borrow from the Fed. It also encourages banks to continue to make credit available to other businesses, who are not necessarily affected by the subprime mortgage mess, but have had a difficult time lately selling commercial paper and other short term financing facilities because banks have been reluctant to make any loans, due to the fallout from the mortgage mess.

The markets reacted positively to the Fed move on Friday, and after reading numerous articles over the weekend, my conclusion is that this was a very good move by the Fed. While it may not stop a further slide in the markets in the short term, it doesn't reinflate the mortgage bubble, because the Federal Funds rate, the rate banks charge each other, hasn't changed. While there is a minority calling for a lowering of the Federal Funds rate, and you can be sure these are the people who are being toasted by their use of leverage, most responsible voices seem to be indicating the system can handle the losses from the subprime mortgage sector and lowering the Federal Funds rate could lead to further speculative excess.

The Dow crossed the 10% correction threshold on Thursday, but managed to close in somewhat better shape and rallied on Friday. While the S&P 500 was down as much as 12% from its July peak intraday on Thursday, it also managed to recover late in the day and rose back to 1,445 by the close on Friday. Where the markets go in the next two weeks is really only an issue, if you have a need for short term cash. If you are invested for the long haul, you ride out the volatility and continue to add to your holdings, for when the markets are down, shrewd investors view it as a sale!

John Kaighn

Jersey Benefits Advisors

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