The Fed rushes in as Wall Street teeters

The world's central banks are shifting their target from the prosperity of Main Street to the survival of Wall Street, seeking new ways to funnel money to major banks and brokerage firms that are struggling to fund their businesses amid the credit crunch.

Concern that Bear Stearns Cos. Inc. would succumb to a liquidity crunch haunted markets Monday and, while stocks rallied yesterday after policy makers rushed to the rescue of the financial sector, credit markets point to a lingering concern that Bear or one of its rivals might not be able to endure.

The U.S. Federal Reserve's surprise move yesterday morning to provide $200-billion (U.S.) of financing to financial institutions, backed by $45-billion of additional commitments from European and Canadian central banks, will enable Bear and peers like Lehman Brothers Holdings Inc. and Merrill Lynch & Co. Inc. to borrow against some of the more troubled securities on their balance sheets. That will free up funding for their main business: lending and financing investment.

This select group of 20 Wall Street firms – known as the “primary dealers” – will be able to take troubled mortgage-backed bonds that almost nobody else wants to the Fed, which will take the securities as collateral. In return, the Fed will lend the firms Treasury bills, which are easily converted to cash.

The move has bigger implications for the financial system than just shoring up a handful of companies.

The Wall Street firms are linchpins of the global financial system.

“This is a good idea because the banks are in such miserable shape that something has to be done to thwart rampant bank failure,” said Rich Yamarone, director of economic research at New York-based Argus Research.

While U.S. Securities and Exchange Commission chairman Christopher Cox said yesterday that the regulator has “a good deal of comfort about the capital cushions that these firms have been on,” the firms have been preserving those cushions by cutting back on activities such as lending to investors.

Firms such as Merrill and Goldman Sachs lend as much as $30 for every dollar they have in capital. That means that the billion-dollar losses that the firms are taking on some securities are having a massive ripple effect.

For example, Bear is the biggest U.S. broker to hedge funds, a role that includes playing lender to funds that want to buy stocks and bonds with borrowed money.

As Bear and other lenders called loans to hedge funds to preserve capital in recent weeks, that prompted a wave of forced selling of assets that has pushed down asset prices. It has also caused a series of high-profile funds to land in distress, including Carlyle Group's Carlyle Capital fund, because they were unable to repay the loans.

By helping Bear, the Fed and its fellow central banks may alleviate that selling pressure, allowing global markets to find their footing.

“This is not about interest rates and it's not about credit; it's all about liquidity,” one senior Wall Street executive said.

“What the Fed did this morning is totally focused on the Bear Stearns of this world.”

In fact, the emphasis on Wall Street over Main Street earned the central banks plaudits from some commentators who are worried about inflation and had feared the Fed would just throw more gasoline on the economy in the form of rate cuts.

“Now they're not stimulating the economy and they're not engendering inflationary pressures with this move,” Mr. Yamarone said. “They are providing a facility for those who are hurting. This is targeted, as opposed to helping everybody whether they need it or not, which is good because that's how bubbles are formed.”