On May 2nd, The Federal Reserve issued a statement about the crisis in liquidity which has bottlenecked global growth for several months. Since last August, banks have written down $300 billion in sub-prime related securities, but the IMF has predicted that the eventual cost will exceed $1 trillion. As major banks unloaded debt over the last half of 2007, their balance sheets became spread too thinly. As a result, they have become increasingly less willing to lend, especially to each other, preferring instead to shore up capital.

The resulting credit crunch has had a knock-on effect on the larger economy, prompting the US central banks to slash the key Federal Funds rate seven consecutive times in as many months, from 5.25 percent to 2%. This policy has resulted in flat or slightly negative real interest rates, but mortgage and other interest rates remain artificially inflated, thus mitigating some of the benefits. Another problem with lowering interest rates is that it is difficult to gauge their effects on market conditions, as they typically take some time to work their way through the financial system.

Indeed, while interest rates have taken most of the headlines, the central bank has also taken extensive action in direct lending to banks. The most well-known example of this marked shift in policy is the Fed-backed bailout of the troubled investment bank Bear Stearns earlier this year. The floundering securities firm had problems with one of its hedge funds in early 2007, leading up to a well-publicized meltdown in March as other banks became wary of lending to them. This eventually forced them to seek emergency assistance, resulting in their buyout by JP Morgan with a guarantee of funding by the Fed to the tune of $29 billion. By extending the so-called "discount window" to an investment bank, the central bank took a de factor role as lender of last resort, a privilege usually reserved for commercial banks. Whether they overstepped any boundaries is now moot, of course. Likely the ensuing panic upon the failure of one of the largest US banks would have been worse than keeping them afloat. Their decision has proven to help provide short-term stability for markets.

Despite regular injections of capital from the European Central Bank, the Bank of England, and the Federal Reserve, investors seem unsure that the end of the credit crunch is nigh. Inflation has reared its head in recent months, leading to global food riots and record gasoline prices. The weakening dollar has contributed greatly, as the oil-producing nations which price their exports in the US currency are forced to raise prices accordingly. Interest rate cuts are likely over for a long while, as the Fed tries to balance continuing liquidity issues with inflation. $600 billion in Fed-issued loans has covered much of the cost of the credit crisis so far, but IMF estimates are only applicable for the numbers used to make them. Unless banks are growing, building capital, or both, liquidity will continue to hamper recovery. It will take time, but restoring confidence for investors and lenders is the only way economic growth can resume.

Ki provides information and analysis on his site about Austin real estate along with providing a search of the Austin MLS. He also posts regular market updates on his Austin real estate blog.

On March 14th, Bear Stearns, the fifth-largest investment bank in the United States, entered a period of insolvency. As growing lack of confidence in the firm's subprime exposure grew, other banks eventually refused to lend to the stricken company, which has existed for over 85 years. Were Bear Stearns a commercial bank, (i.e. institutions that loan money to people or businesses) it would be able to, as a last resort, take advantage of the Federal Reserve's so-called "discount window," thus receiving a government loan at the lowest available interest rate. The reasoning behind making loans to private businesses is sound, because overall confidence in banks is much stronger. But for equally obvious reasons, the discount window cannot by definition extend to institutions that take on risk as their business because they have less or no accountability to taxpayers.

However, after Bear Stearns seemed on the brink of collapse, everything changed. Bear Stearns shares began to falter as investors took flight. The Federal Reserve took decisive action to save the beleaguered bank by guaranteeing a $30 billion loan to their biggest competitor, JPMorgan Chase, so they could buy BS without fear of acquiring more dangerous subprime mortgage-related debt. In effect the government has now bought a troubled investment bank for pennies on the dollar, (their first offer was $2 a share, when BS traded at a high of $170 a year ago) knowing that taxpayers might have to foot the entire bill themselves. At the same time, the Bush administration has maintained that no government bailouts would extend to the financial sector. Moreover, wealthy BS shareholders balked so much at the firesale of their investments that the Fed, under pressure from potential litigation, increased the bid for BS by five times, to $10 a share. This means that, while the potential losses will be felt by millions of taxpayers (many of whom are in danger of losing their homes to foreclosure), while profits will most certainly be reaped by the corporate executives at JPMorgan.

Even with its exceptional exposure to subprime securities, BS is still worth well over a billion dollars. Profit-taking was the name of the game on the heels of the announcement, as day traders bought up huge amounts of BS stock at $2 or $3 a share and sold after the bid increased. By taking responsibility for the BS takeover, the Fed has changed the course of America's financial future. By guaranteeing the discount rate to BS, they implicitly must be able to do so for other investment banks in trouble in the future, which implies continued taxpayer absorption of Wall Street failures without any corresponding kickback from banks. Unless the Fed intend to rein in on banks more as the economy struggles through the recession, this policy clearly demonstrates a dramatically different view of finance than the Federal Reserve of 1913, when there was a real discount window you could use to keep your bank alive. Now, it seems, the most secure economically secure institutions are those most separated from average American lives. Politicians who recognize the increasing resonance of populist messages in the present climate are sure to turn this takeover into a major issue.

Ki works and lives in Austin Texas. As a realtor he helps investors interested in Austin real estate. His site provides a search of the Austin MLS for visitors along with a Austin real estate blog to keep people up to date on the market.

In recent days, the Federal Reserve, the European Central Bank, the Bank of Canada, the Bank of England, and the Swiss National Bank have teamed up to auction $110 billion off to world money markets in order to ease the recent liquidity crisis. But what is liquidity? Why should banks auction off money to deal with it? And how does inflation play into this phenomenon? Well, for starters, liquidity refers to the amount of money available in a given market that can be loaned from one entity to another. If an economy is looked at as a machine, with thousands of interconnected parts, then liquidity functions like oil, keeping all the moving components lubricated. If there is not enough liquidity in the market, loans become more expensive and time-consuming, and economic growth is inherently restricted because banks are less willing to lend to each other, in case they are unable to cover their deposits. The Northern Rock bank runs in England are a perfect example of what happens when a bank cannot make good on their deposits. In today's globalized economy, banks depend on lighting-fast transactions of large sums through all parts of the world. If they are wary of lending to each other, as recent events have shown, currency supplies start drying up. With this in mind, the sub-prime crisis of recent months seems poised to further restrict growth, especially in the US. The central bank's decision to add money into the economy is designed to keep cash-flow consistent in markets, which will also hopefully help boost investor confidence. Unfortunately, the sub-prime debt still exists, and banks are unlikely to lower the inter-bank borrowing rates much until all the debt is declared on balance sheets. And with 2 million more defaults likely to occur within the next year, the crisis is far from over. This injection of cash implies that central banks are trying to stem a problem they recognize to be quite severe, as they have never taken such concerted, coordinated action before. But their course will certainly impact the other primary concern, that which central banks must balance liquidity with: inflation. This refers to price increases, which make currencies less valuable. If it takes $10 tomorrow to buy a Big Mac, then the US dollar has lost about 40 all at once, likely the outcome would be different. Only time will tell whether the huge cash injection will be enough to help banks lower their rates back to more growth-friendly levels. Working as a realtor in Austin Texas Ki runs a site about Austin Texas real estate which provides users a map based Austin MLS search. Also if you are looking for in depth commentary on real estate market Ki has a blog covering Austin real estate.