The AFR couldn’t have been more wrong with its headline today: ”Markets roar back as investors cheer Fed action”. The paper should have had something life: “Relief rally sees markets bounce”, because the cheering got awfully muted in the US as the casualty list continued to grow in financial markets.

In fact the rally turned feline and died, slowly, trading in a 200 point range and ending in uncertainty.

Some of yesterday’s big rise in Australia was just plain over the top and you wouldn’t be wrong in thinking that there were some bunnies buying in the belief that the Federal Reserve had cut its key interest rate: it hasn’t because if it does it will send a message that it sees the US slumping into recession.

The Dow edged up 42 points and closed looking weak. The broader Standard & Poor’s 500 index, the key benchmark for professional investors, actually fell after Friday’s strong rebound. Which is why you should ignore what is being said and written about local markets and valuations: the fear and paranoia in US and European money markets is the driving factor at the moment.

And it’s no wonder. Big home loan lender and bank Capital One Financial Corp has shut its mortgage manufacturing unit with the loss of around 1,900 jobs. The business produced mortgages and sold them through brokers. It said in a statement that it expects a charge of about $US860 million (or around $A1.05 billion), but will still make a smaller profit this year.

Bear Stearns closed its mortgage operations last week at a cost of 240 jobs and over 30 other mortgage groups have cut thousands of jobs because of losses (Big names GE Money and GMAC have cut back or sold out of subprime mortgages, while American Home Mortgage has collapsed).

Another mortgage group, Thornburg Mortgage which specialises in so-called “jumbo-mortgages” (which are larger than the Federal insurance limit of $US417,000) says it will take a loss of $US930 million, or more than $A1.1 billion) on high-rated investment securities it sold to raise much needed money to cut its debts.

The company said it sold more than $US20 billion of securities at a discount to raise the money because it couldn’t refinance some of its borrowings. It has postponed trying to re-start its lending operations from today to early next month because of the difficult market conditions.

It’s not the first big home lender to do that. Here Rams took up a $A1 billion emergency loan from two banks when it couldn’t rollover $6.17 billion in short-term debts, and Countrywide Financial Services, America’s biggest mortgage lender took up a $A13 billion line of credit to help restore its finances.

Meanwhile, KKR Financial, part of the KKR private equity group is taking similar action by revealing plans to try and raise half a billion US dollars from investors to help restore its finances. It lost $US55 million in selling securities last week.

KKR Financial will sell some of the shares to investment banks and investors and executives of KKR have said they will provide $US100 million in a ‘backstop commitment’ if there’s a shortfall.

And, another hedge fund has been forced to start liquidating its assets because of huge losses.

The $US1.5 billion British-based fund run by Solent Capital called Mainsail II invested in credit securities such as bonds backed by mortgages and collateralised debt obligations and finance around 90% of that by borrowing short term. That market has locked up and Mainsail has been forced to luff and tack to keep afloat.

It’s another in a long and growing list of European hedge funds, investment funds and banks and finance companies that have lost well over $A70 billion. That includes two German banks.

And it’s because of these continuing problems that the hard heads among investors ignored the relief rallies on stock markets and headed for, or increased, their cash holdings.

They see worse ahead and that attitude saw yields on short term US Government debt had their sharpest fall for 20 years. Three-month Treasury bills ended 0.66% lower at 3.09%, the biggest fall since the October 1987 market crash and bigger than the fall after September 11. The yield has fallen from 4.69% eight days ago.

Yields on 10 year bonds fell to 4.63%: and it seems the Fed’s actions last Friday have yet to convince markets.