Federal Reserve slashes interest rates
The Federal Reserve has cut interest rates in the US by 75 basis points to 2.25% in a bid to restore confidence in the financial markets.
And the Bank of East Asia has said it will cut its prime lending rate in Hong Kong by half a percentage point to 5.5%.
The moves follow stockmarkets across the world experiencing heavy losses on Monday - the aftermath of the emergency bailout of the US investment bank Bear Stearns.
The fifth-largest investment bank saw its share value fall by 46% to just $30 (£15) last Friday (14 March) after sub-prime write-downs of $3.2 billion. Rumours of a cash shortage led to a run on the bank with investors withdrawing around $17 billion.
However, JPMorgan Chase stepped up as its knight in shining armour over the weekend, buying the credit crunch-stricken bank for $2 a share. This values Bear Stearns at just $236 million (£116 million). The Federal Reserve is to fund up to $30 billion of the bank's assets in return for JPMorgan guaranteeing all its due payments.
The Federal Reserve says the 75 basis point cut in interest rates should help "promote moderate growth over time and to mitigate the risks to economic activity".
But it warns: "Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened.
"Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters....downside risks to growth remain."
Experts were predicting a cut of at least 1%, suggesting that the Fed has confidence in the market's ability to ride out the crisis.
Impact on the UK
Although the FTSE 100 closed last night 217 points down on Monday, it
made a recovery the next morning and eventually closed up 3.54% at
5,605 points. Similar rises were seen across Europe on Tuesday with the
Dax in Frankfurt rising by 1.8%, and in Paris the Cac was up 1.9%. In
New York the Dow Jones is climbing again up 21 points at 11972.3.
Bear Stearns' collapse could have an impact on the finances of many Brits, not just investors.
Some experts are pointing fingers at other investment banks, warning they could be the next names to hit the headlines with further sub-prime write-downs and liquidity issues.
Simon Denham, managing director at Capital Spreads, warns that the survival of other investment banks are fragile in the current nervous climate.
He said: “Speculation will now focus on the other weak investment banks. Mere rumour was enough to ruin it for Bear Stearns as deposit holders rushed to extract their funds - now we actually have a factual failure. Who is going to risk being a deposit holder in the next domino to fall?
“In this scenario we could see the destruction of several institutions over a very short period of time and the eventual rise of just a few “super” entities.”
As banks suffer the after-effects of the credit crunch, they continue to take steps to recoup their losses. Unsurprisingly, mortgages are one area nearly all banks have cracked down on – partly because lax lending in the US is one of the main causes of the current market turmoil but also because a slowing housing market means this sector doesn’t look as attractive as it did a year ago.
Banks are no longer willing to lend money to just anybody – in fact, the criteria they look at to determine your borrowing risk has tightened significantly. This means that if your credit profile is not squeaky clean you may find it hard to get a mortgage or loan at an attractive rate.
Secondly, lenders are also expecting borrowers to put more of their own money into a property. Nationwide will no longer offer its most attractive mortgage rates to borrowers unless then have at least a 25% deposit to put down. And 125% mortgages, which lend over the value of the property, are no longer offered by lenders despite their popularity among first-time buyers last year.
Finally, mortgage rates have increased and are likely to continue to do so. Interbank interest rates – known as LIBOR – have been creeping up for some time and now stand at 5.84%, meaning it is increasingly expensive for banks to borrow credit to fund their lending activities.
Angela Knight, chief executive of the British Bankers’ Association, said the continued rise of LIBOR rates reflects increasing liquidity pressures in funding markets internationally.
It's not just mortgage borrowers who are suffering. Some credit card customers have already seen their credit limits slashed, and providers such as Egg have withdrawn cards from customers they deem high risk.
However, one silver lining could be for savers. Banks are keen to increase their customer deposits and may therefore increase their rates in order to entice more savers through their doors.
The Bank of England might also be forced to react to the turmoil, cutting interest rates when it next meets in April. This could ease pressure for banks and bring mortgage rates down.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The London Inter-Bank Offer Rate is the rate at which banks lend to each other over the short term from overnight to five years. The LIBOR market enables banks to cover temporary shortages of capital by borrowing from banks with surpluses and vice versa and reduces the need for each bank to hold large quantities of liquid assets (cash), enabling it to release funds for more profitable lending. LIBOR rates are used to determine interest rates on many types of loan and credit products such as credit cards, adjustable rate mortgages and business loans.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.