The Federal Reserve took dramatic measures this past week to try to inject a little calm amidst the concern over not only the housing market, but Wall Street and the credit crunch as well. To begin with, the Fed assisted in the sale of Bear Stearns, one of Wall Street’s biggest and most storied banks. The Fed extended a $30 billion (yes that’s a B) credit line to JP Morgan, their rival. Bear Stearns was about to collapse due to major losses in the mortgage market. To put this into perspective of how serious this situation was, let’s look at Bear Stearns for a minute. 85 years on Wall Street. Yep. JP Morgan buys them for about $2.00 per share. Yep. Bear Stearns stock was trading near $30 a share on Friday and their building is worth about $1 billion alone. Huh? Exactly! Bear Stearns was running so low on cash, facing major press about their mortgage losses, and clients were pulling their cash out like it was bobble head day at the ATM. They had no choice. To stay in business they needed a cash flow injection and fast.

What about their shareholders? Their acquired wealth may be eliminated. And thus sets the wheels in motion for a nasty domino effect. The Fed’s moves raise questions about just how deep the financial industry’s woes go — and what other banks might be at risk.

In addition, the Fed lowered the discount-lending rate — that’s the rate which it charges banks for very short-term loans by a quarter-point, to 3.25, on Sunday. It followed that on Tuesday with a cut of three-quarters of a percentage point to another key interest rate, the federal funds rate. See the cause and effect on this rate drop from an earlier post.

All of our financial markets right now are very unsteady. What people are concerned with, and rightfully so, is that if a historic giant can tumble like Bear Stearns, are other institutions at risk? The worst thing that could happen would be a run on the other banks, further worsening their liquidity and essentially stopping all of the financial markets dead in their tracks.

It is hard for me as a layman to put this in terms that exactly point out how critical this is for our economy. Simply stated, with out these investment banks like Bear Stearns, JP Morgan, Lehman, etc. our cash flow dries up. if you or I were to miss a paycheck for a few months you can see the effect that would have on your household. Multiply that times by billions and that is the effect the country will feel.

So, with these banks feeling this significant crunch, they are hesitant to lend each other money. No one can really say how much bad debt these banks actually have. One would guess that those who have the most exposure to sub prime mortgages and other risky products would be on the list. Wall Steet whispers mention UBS and Lehman Brothers beacause of their exposure to these mortgage related securities.

Tags: real estate, sub prime mortgages, Wall Street