What might have changed his mind?

Fed Offers Wall Street a Rate Reprieve
August 17, 2007, 9:05 am Link to This E-mail This Topics Investment BankingIndustries Financial ServicesThe Federal Reserve unexpectedly announced Friday that it has approved a half-percentage point cut in its discount rate on loans to banks, a move that many on Wall Street had been clamoring for. The decision came as stock markets have been whipsawed by speculation about which mortgage company or hedge fund could be the next to fall victim to the recent credit crunch.

The decision, which sent stocks sharply higher early Friday, could prove controversial. Some have argued that the Fed should allow the turbulence in the credit markets to play itself out, rather than offering a lifeline to fund managers and mortgage lenders who made risky bets.

Stock-index futures rallied in premarket trading Friday, as did shares of financial firms such as Citigroup and Lehman Brothers.

“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward,'’ the central bank’s Federal Open Market Committee said in a statement. “The downside risks have increased appreciably.'’

A sudden spike in defaults in subprime mortgages, which are loans to homeowners with weak credit histories, has reverberated through the markets in recent weeks. It has led to a virtual freeze on the financing used to fund leveraged buyouts, much to the chagrin of private equity firms. It has also made it much more difficult for finance companies to sell commercial paper, a common source of short-term funding.

The market disruptions have also stung some major hedge funds, including two funds run by Bear Stearns, which were forced to seek bankruptcy protection. Even hedge funds with little exposure to mortgage-related securities have suffered big losses this month because of the unusual market moves.

Many in the financial industry have been crying out for an accommodative move from the Fed. This was most theatrically demonstrated by James Cramer, the hedge-fund manager turned “Mad Money” host, who, in an interview this month on CNBC, alternately pleaded with and berated the Fed, in hopes of persuading it to take steps to ease the credit crunch.

On Aug. 5, New York Times reporter Alex Berenson described the dilemma facing Federal Reserve chairman Ben Bernanke this way:

In essence, Mr. Bernanke faces a choice of keeping credit relatively tight for now — and thus reducing the risk of bubbles for years to come — or loosening credit and lowering the chance of an economic slowdown in the next few months.

Until Friday, many thought Mr. Bernanke would stand pat.

What might have changed his mind? That’s not entirely clear. But some analysts this week have begun to flag the possibility that Countrywide Financial could be forced into bankruptcy if the liquidity squeeze persists. The prospect, however unlikely, of a shutdown at the nation’s largest mortgage lender could have been a factor in his calculations.