From what I understand (kinda out of the loop at the moment) the Fed did two big things this week.
1. Open the discount window.
2. Buy up many billion dollars of mortgage securities.
Re: point 1, this is what Cramer was ranted about recently. Again, from my understanding, this is creating special short-term loans to banks at very low rates. I assume this is to get some liquidity into over-leveraged banks to keep them from failing.
Re: point 2, this is more interesting (IMHO). Considering that a mortage is like an IOU, a CDO is just a big bag of IOU’s. And since every IOU has some risk associated with it, they are graded and stuffed into bags of supposedly similarly risky loans and then sold to investors.
Now, the problem that is surfacing, is that apparently these valuations are turning out to be largely worthless. Ergo, investors don’t want to touch even highly-rated mortage securities now, let alone the crap (subprime) ones. At least until they can be re-graded to something that more resembles reality.
At this point, Enter the Fed. In what I think is an unprecedented move, the Fed just went in and bought up a big chunk of the highest-risk (subprime) loans. They claim this was done with ‘reserve’ currency, which I think is BS. I’m sure they just threw more coal into the boiler that powers the printing presses.
The short-term effects of this remain to be seen. They may have averted a panic (no way to know, however) or may incite one, as this is a clear indicator that the secondary mortgage market is becoming insolvent.
The long-effects of this is that all of our wallets and saving accounts just got a little bit lighter, as the new dollars erode the value of the existing ones.
