Government Responds to Market Instability

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, and Securities and Exchange Commission Chairman Christopher Cox met with congressional leaders in Washington on Thursday night to create a plan to try and calm the roiling financial markets. 

Their announcement on Friday morning is changing the financial markets around the world. Here’s what they did:

  • SEC temporarily bans investors from short-selling 799 financial companies.
  • US Government guarantees money market funds.
  • A plan to create legislation to remove devalued mortgage assets from companies’ balance sheets is currently in the works.

Additional Steps:

  • Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities.
  • Secretary Henry Paulson, and Treasury will expand the MBS purchase program announced earlier this month to help facilitate mortgage availability and affordability.

SEC temporarily bans investors from short-selling 799 financial companies.
Short selling is a common trading method in which investors bet that the stocks will go down by “borrowing” shares at a higher price and selling them in the open market at a lower price. The SEC said short sellers “add liquidity to the markets during normal conditions, but recent unbridled short selling has contributed to the recent tailspin in the stock market.” The SEC has banned this practice for 10 days, which can be extended for 30-day increments. On Wednesday, the SEC also banned “naked” short-selling, in which investors short the stock without actually borrowing it first. On Thursday, Britain’s Financial Services Authority also temporarily banned short-selling for financial companies.

Hopefully, this will add another level of calm to the current financial crisis.

US Government guarantees money market funds.
The US Treasury said its decision to provide guarantees “should enhance market confidence and alleviate investors’ concerns about the ability for money market mutual funds to absorb a loss.” According to Treasury Secretary Henry Paulson, “Nearly $2 trillion in money market mutual fund assets will be covered by the guarantees.” European Central Bank, Swiss National Bank and Bank of England also offered up more cash Friday – a combined $90 billion into money markets. It should be noted that this does not include high-yield, enhanced type, or riskier money market funds.

A plan to remove devalued mortgage assets from companies’ balance sheets.
“Illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions,” said Treasury Secretary Paulson. “As a result, Americans’ personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.” To restore confidence in our markets and our financial institutions, the federal government will create a new vehicle to purchase this mortgage debt and provide a liquid marketplace.

These three steps will not fix everything, but it’s a major step in the right direction for the overall health of our financial systems.

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