Platform:Bear Stearns, the financial institution whose ill-judged foray into hedge-fund management was the catalyst for much of the market volatility of the last month, decided that it might regain some credibility by asking for the resignation of co-president Warren Spector.
It's not often that you see a high-profile person carrying the can for a firm's difficulties, but Spector was responsible for the fixed income and asset management areas and clearly the knives were out when the bank's shares plummeted in the wake of the losses at two hedge funds which filed for bankruptcy on July 31st.
The hedge funds had invested heavily in subprime mortgage lending which, thanks to the continued tight monetary policies of the Fed, has taken a battering over the last 12 months. Bear Stearns has seen the value of its shares plummet over the year and decided that the erstwhile candidate to succeed the current chief executive, James Cayne, had to go, especially when the outlook for the bank's own credit rating was cut. A lower credit rating makes Bear Stearn's own bonds less acceptable to investors and, in turn, makes the cost of raising funds on the market more expensive to the bank.
However, market reaction wasn't initially what the bank's management would have liked. The feeling is that Cayne is playing the blame game, but some analysts are suggesting that by making Spector carry the can, management is implying that there were no other controls on what was going on and, as a result, the shares continued to slide. Standard & Poors, the ratings agency which changed its outlook on the bank to negative, commented that market reaction to its decision was "overdone" and the bank's liquidity situation was "solid". And with the shares at their lowest level for three years, it became apparent that investors would soon begin nibbling at the stock again.
This week has seen financials come back into favour as traders decided that they had punished the sector enough for its poor lending decisions in the subprime market, although many still feel that there may be some skeletons rattling around in that particular cupboard.
American Home Mortgage (AHM), the 10th largest home lender in the US, filed for bankruptcy this week after banks refused it further credit (banks are clearly taking a firmer line in the wholesale markets than they did in the subprime lending area). AHM had issued about $60 billion (€43 billion) in loans last year in a market that is now seeing default rates above 12 per cent.
The recent market volatility is being caused by the fortunes of those involved in subprime and the effect it is having on credit institutions. Traders are reacting wildly to positive and negative news - a sure sign that fear currently has the upper hand over greed!
In all this, the focus is also on the Fed's reactions. There is now the opinion that it should consider a more accommodative interest rate regime. The argument is that the problems in the credit markets are almost entirely due to mortgage lending, but thanks to the Fed's tightening policy, everyone else is getting caught in the squeeze. Now it is more expensive for companies to service credit for capital projects or expansion or even to cover cashflow. That could further damage the economy.
The Fed's tighter policy came as a result of its concern about inflationary risks in a growing economy. Although many people have been concerned about the quality of bank lending, and the way in which money was lent to those with difficulties in repaying it, those concerns were sacrificed to the altar of continuing growth. Now it seems the Fed may not be able to afford to let the market take the full pain of its own actions because in doing so, it might inflict additional pain on people who haven't been part of the great house of cards.
Yet the truth is that easy credit is not a universally good thing and can have as much an adverse affect on markets as a policy that is too restrictive.
Comments from the Fed have been designed to soothe - governor Randall Kroszner told the Senate Banking Committee the fundamentals were "unchanged" and the Fed suggested that with profitability at the majority of S&P index companies higher than last year, they weren't under immediate pressure. William Poole, of the St Louis Fed, said recent volatility was a "typical market upset".
The Fed's actions over the next few months will show whether they believe their own rhetoric or not.
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