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"Sub-Prime Collapse Beyond US Federal Reserve"

www.news.com.au/business/money/story/0,25479,23393912-462,00...
*US Federal Reserve 'lacking funds to help crisis'
*Losses yet to come 'easily exceed remaining $400bn'
*Not going to be able to deal with situation on own
*FEARS are growing that the US Federal Reserve may soon find itself short of the funds needed to continue propping up the nation's financial system.

The central bank yesterday used its financial muscle to back the bail-out of the stricken Wall Street investment banking giant Bear Stearns, which will be taken over by rival JPMorgan Chase at a fraction of its worth last week.

But analysts believe the threat to the financial system, which continues to flow from the collapse of the sub-prime mortage market last year, is getting too big for the Federal Reserve.

"This is now beyond the Fed," ANZ international economist Amy Auster said.

" It is not going to be able to deal with this situation on its own."

Cash reserves drying up

She said the US central bank had already extended support of about $US400 billion ($426 billion) to the US financial system, compared with its assets of $US800 billion.

She said financial system losses yet to be reported could easily exceed another $US400 billion.

"What is missing at the moment is the US Treasury," she said.

But Treasury Secretary Hank Paulson has already declared his hostility to federal measures to help the sinking financial sector.

"Let me be clear: I oppose any bail-out," he said in a speech 10 days ago.

"Most of the proposals I've seen would do more harm than good - bailing out investors, lenders or speculators who, instead of getting a free pass, should be accountable for the risks they took," he said. "

I believe our efforts are best focused on helping homeowners who want to stay in their homes."

More could follow Bear Stearns

There remains a vast quantity of financial assets of doubtful value that will expose banks and other financial institutions to the kind of panic that brought investment bank Bear Stearns to the brink of disaster on the weekend.

"When the fifth-largest investment bank is in trouble, you have to become concerned about the solvency of the system and the banks in the system," Ms Auster said.

In 2006 alone, there were $US550 billion of "collateralised debt obligations" issued, she said.

These are the bundles of mortgages and other securities that have been at the heart of the sub-prime crisis.

Ms Auster said the market for these securities depended upon the ratings agencies, bond insurance and collateral.

"All three elements of this infrastructure - the three bands of the bridge have collapsed," she said.

When the Federal Reserve announced its extraordinary Sunday afternoon bail-out of Bear Stearns, it also extended a lifeline to all the other major investment banks, offering them access to emergency funding for the first time since the 1930s.

As in Australia, the central bank is assumed to be the lender of last resort for the commercial banks, which take deposits from the public, but not for investment banks and stockbroking firms.

But the tangled web of counter-party arrangements that has developed between financial institutions over the past decade means that allowing Bear Stearns to go broke would have jeopardised major banks.

"If Bear Stearns defaulted on their paper, it would pull at least another bank down," senior economist with finance broker ICAP, Matthew Johnson, said.

Drop in the ocean

Mr Johnson said he estimated the Federal Reserve was halfway through the ammunition it had to deal with the crisis.

"The $US450 billion remaining is a drop in the ocean compared to the asset classes in trouble," he said, noting that in addition to mortgage-related debt, some of the big private equity deals were beginning to unravel.

The biggest risk to the real economy is that credit dries up, as bankers become scared to lend.

Morgan Stanley chief economist Gerard Minack said while the Federal Reserve was cutting interest rates, its efforts were being neutralised by the banks.

"Nobody is enjoying easier financial conditions," he said.

Mr Minack said there were no grounds for equating the coming recession in the US to the Great Depression, but it could still be as nasty as the downturn in 1974.

Ms Auster said Australia would not escape the effect of the recession, with its share market having already fallen further than US markets.



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