Central Banks Intervene to Calm Volatile Markets

Central banks around the
world acted in unison yesterday to calm nervous financial markets by
providing an infusion of cash to the system. But stocks still fell
sharply in Asia and Europe, and in early trading in New York, before
they recovered and closed essentially flat for the day on Wall Street.

As in recent weeks, the markets moved in wild swings — sharp
drops were followed by steep gains and vice versa — underscoring
the uncertainty. Investors weighed concerns that losses in the American
mortgage market would deepen and spread against their faith in the
ability of a strong global economy to withstand additional shocks.

Hoping to provide some comfort that there is ample cash available,
the Federal Reserve made its largest intervention since the markets
reopened Sept. 19, 2001, in the wake of the terrorist attacks. The
central bank injected $38 billion into the financial system on top of
the $24 billion it put in on Thursday.

The intervention steadied the markets — at least for the day.
The Standard & Poor’s 500-stock index closed at 1,453.64, a
gain of 0.55 point, and the Dow Jones industrial average closed down
31.14 points, to 13,239.54. For the week, the Dow was up 0.4 percent,
the S.& P. 500 rose 1.4 percent and the Nasdaq was up 1.3 percent.

The question that remains is just how exposed the financial system
and the economy are to losses in the credit markets and the increase in
borrowing costs. The answer will set the agenda at the Federal Reserve,
which finds itself confronting its first major financial crisis under
the leadership of Ben S. Bernanke, who took over last year.

The Fed will be guided by its assessment of how much do banks, hedge
funds, pension funds and others stand to lose and whether consumers and
businesses will be able to stomach higher interest rates and stricter
loan underwriting.

“There are a lot of risks in front of us,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Financial crises, in the past, when not accompanied with a recession have been good for the markets.”

But, she added, “if the economic landscape deteriorates much
from here, then we are going to have to suffer through a more difficult
market period.”

That debate, Ms. Sonders and others agree, will not be resolved
anytime soon, which suggests that markets will remain choppy as
information about failing hedge funds and mortgage companies dribbles
out.

Investor anxiety has been so heightened in recent weeks that days of
stability have been shattered by the first sign of trouble tied to the
debt markets.

Volatility, as measured by one popular index of options trading, has
surged to its highest levels in more than four years, though it remains
far lower than it was early this decade and in the late 1990s.

The financial sector has been among the most volatile — stocks
there fell by as much as 1.7 percent during the day, only to climb as
much as 1.1 percent before closing little changed.

Shares of Countrywide Financial, the nation’s largest mortgage lender, and Washington Mutual,
the sixth-biggest lender, opened sharply lower after both companies
said they were facing a harder time selling loans and could potentially
have problems raising money.

While those stocks recovered much of their losses for the day, they are both down significantly for the year.

A common pattern has been a surge in trading late in the afternoon,
around 3 p.m., that has often sent stocks higher, as it did yesterday
— though on some days, like Thursday, the move has been just as
sharp on the downside.

Richard X. Bove, an analyst at Punk Ziegel & Company, noted the
trend in a recent note to investors and suggested that the reason was
strong buying from portfolios that use computer models to buy and sell
quickly, a practice known as program trading, or a foreign source like
the investment arm of the Chinese government.

“We are talking about such a sizable amount of buying and
volume goes up and stocks react strongly one way or the other,”
Mr. Bove said. “What I have trouble with is trying to figure out
where it’s coming from.”

But he acknowledges that the pattern will probably not last long,
because as sophisticated traders figure it out they will jump in on the
other side to profit from the trades.

Using data from the New York Stock Exchange,
Ms. Sonders of Charles Schwab estimates that program trading accounted
for about 40 percent of all trades on the Big Board in recent days, up
from the 30 percent range earlier this year.

“That’s why we are getting these swings, this is
professional- to-professional trading,” she said. “This is
money that has a time horizon measured in minutes.”

Indeed, there is evidence that the average individual investor has not been a big player in recent days.

Flows into mutual funds that specialize in American stocks were
essentially flat for the week that ended on Wednesday, according to AMG
Data Services. But investors put $36.2 billion into money market
accounts, the largest weekly inflow this year. Investors often put cash
into money market funds, which earn more than savings accounts, that
they eventually plan to invest in the market.

It is not surprising that individuals are sitting on the sidelines,
given the sharp moves in the market. Yesterday, for instance, all three
major American indexes fell immediately after the opening bell, and at
one point the Dow Jones industrial average was down 212 points. By
noon, stocks were on the rebound and the indexes were briefly in
positive territory, then declined. The Nasdaq finished at 2,544.89,
down 11.60, or 0.4 percent.

“You can’t invest into a market that does that,”
Mr. Bove said. “You have a better chance at making money on the
craps table than in this market.”

Treasury prices were little changed yesterday. The 10-year note fell
9/32, to 99 18/32 and the yield, which moves in the opposite direction
from the price, rose to 4.81 percent, from 4.77 percent on Thursday.

Earlier, stocks in Japan, Hong Kong and Australia dropped by more
than 2.5 percent. The benchmark Kospi in South Korea fell 4.3 percent,
the biggest decline since June 2004. Most major European indexes
plunged by 3 percent or more.

In both Asia and Europe, fears about the American housing market
prompted investors to sell assets and forced commercial banks to reel
in credit lines.

Central banks around the work stepped up efforts to slow the losses.
The Bank of Japan added liquidity for the first time since the market
problems began.

The European Central Bank
injected money into the system for a second day, adding another 61
billion euros ($84 billion), after providing 95 billion euros the day
before. The Federal Reserve yesterday added $19 billion to the system
through the purchase of mortgage-backed securities, then another $19
billion in three-day repurchase agreements.

In Washington, Treasury Secretary Henry M. Paulson Jr.
spent the day in what his aides said was hourly contact with the Fed,
other officials in the administration, finance ministries and
regulators overseas and people on Wall Street — where until last
year he had worked as an executive at Goldman Sachs.

“We’ve been in touch with our colleagues in other
agencies and among the financial regulators and are monitoring the
situation carefully,” said Michele Davis, the Treasury Department
spokeswoman. “Beyond that, we are not commenting.”

As investors in Asia sold off assets considered relatively risky,
like Philippine stocks, they bought those considered safer, like
Japanese government bonds. Asian currencies like the Thai baht also
retreated against the dollar and more liquid and stable currencies like
the yen.

“Everyone’s been talking about a credit crunch, and not
surprisingly it turned into one,” said Jan Lambregts, head of
Asia research at Rabobank.

While Asian banks did not seem to be directly affected, he said,
“the main problem is we don’t know who is bearing the
losses, and that kind of uncertainty is creating the situation that
we’re in right now.”

Central Banks Intervene to Calm Volatile Markets – New York Times

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