A drop in the oil price of more than $US5 a barrel and soothing comments from US Fed chairman Ben Bernanke helped Wall Street rebound overnight, but in another example of investor blindness, they missed the significance of the Fed chairman’s comments: oil prices will continue to bounce around while there’s doubt about the certainty of supply and demand from emerging economies.

The Fed chairman made his comments in a formal speech so it was a deliberate strategy. He was out to tell the mendicant commercial and investment banks that the Fed’s money tap would remain open for a while yet.

Although short-term funding markets remain strained, they have improved somewhat since March, reflecting the availability of several Fed lending facilities as well as the ongoing efforts of financial firms to repair their balance sheets and increase their liquidity.

We are currently monitoring developments in financial markets closely and considering several options, including extending the duration of our facilities for primary dealers beyond year-end, should the current unusual and exigent circumstances continue to prevail in dealer funding markets.

When taken with comments from the head of JP Morgan that credit losses were slowing and there was interest from buyers, Wall Street thought, “Goody, let’s buy.” When oil prices tumbled $US5 a barrel, the traders said, let’s party: up went airlines, car companies, retailers and banks and other financials. Down went oil and energy groups.

US financials stocks climbed sharply, adding nearly 6% in value in the best day’s trading since early April. The news provided hope to a sector after a volatile start to the week in which financial stocks re-tested five year lows and lower in many cases. Driving this unease were suggestions that the US quasi-Government mortgage groups Freddie Mac and Fannie Mae, might have to raise up to $US75 billion in fresh capital to retain their triple A credit ratings.

But Bernanke’s comments aren’t a positive for the market, or the US economy. It’s a recognition that US financial firms are still too weak to stand on their own in the markets and fund themselves, especially investment banks. If the Fed shut its funding facilities down right now, the Lehman Brothers investment bank would be top of the list to follow Bear Stearns, and several US regional banks would be candidates for rescuing.

The Fed’s funding is a form of financial life support. And it should also be remembered that one of those on that life support from the Fed, via the Bear Stearns rescue back up, is JP Morgan, hence its optimism.

And when financial groups are short of capital and borrowing from the Fed, they don’t have enough money to play with hedge funds, private equity, leveraged bonds, takeovers and the like; they merely do enough to keep existing business ticking over. Mortgage lending is being cut back and will continue to be reduced while ever the banks are in their current state.

This was illustrated by the plunging fortunes of a US mortgage group IndyMac Bancorp (it was the second largest last year behind the Countrywide group, now taken over by bank of America). Its shares fell 38% to just 44 US cents. It’s been told by regulators that it doesn’t have enough capital. Shareholders could be wiped out. Someone might take it over at a knock down price, but don’t be on it.

Unlike Bear Stearns, it won’t be rescued by the Fed if it fails. But its loss will be another body blow to confidence in banks and home mortgages. And speaking of home lending, there was a further reminder, again ignored by the market, of where the flashpoint remains for the entire disaster.

The US housing sector is still sliding. An index that measures pending US home sales fell 4.7% in may, more than expected and is now more than 14% down on a year ago. America’s National Association of Realtors index measures contracts that have been agreed but have not yet completed. It’s a lead indicator for actual home sales and it surprised with a fall 50% greater than the 3% drop forecast by the market. The fall was spread across the country.

Mr Bernanke also indicated in his speech the Fed would release fresh guidelines on mortgage lending next week. Will they matter in the current climate?

PS: Watch Bradford and Bingley: the sharemarket price is still below the 55 pence price for its much needed rights issue. The shares fell 19% to 34 pence yesterday. That’s troubling investors and brokers, some of whom reckon it’s headed lower.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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