America’s new war

America today announced the steepest interest rate cut in over 23 years, scrambling to stem a borderless stocks rout that drove down prices for the second consecutive day in India, too.

The US Federal Reserve’s shock slash — the financial equivalent of a bombing run to calm the terror in markets — did not prevent a slide on Wall Street when trading resumed after a holiday but the decline was shallower than feared.
The Federal Reserve, headed by Ben Bernanke, stunned the financial world by trimming the federal funds rate — the overnight lending rate between banks — by a hefty three-quarters of a percentage point to 3.5 per cent, its lowest level since September 2005.

The move was designed to jumpstart the US economy and halt the steep losses in global equities.

The Dow Jones industrial average was down almost 400 points at one stage but, by mid-morning in America, it had cut those losses in half and was ruling at 11913.39, down 185.91 points. European stocks staged a more robust recovery.

If the Dow recovers, markets around Asia will open strong tomorrow and investors can hope for a break from the nightmare of the past week.

However, analysts warned that short-term measures like rate cuts — an age-old tonic to rejuvenate markets — were not enough to erase investors’ concerns. How the US tackles the mortgage crisis will hold the key to a sustained recovery.

Earlier in the day, the Indian stock markets witnessed another bloodbath as the sensex fell sharply a minute after the markets opened, which sparked an hour-long suspension of trading.

After a little help from state-owned financial institutions and wild fluctuations that saw the sensex lose over 2200 points and regain over 1000, the index closed the day with a loss of 875.41 points over the previous day.

Finance minister P. Chidambaram tried to soothe frazzled investors for the second day. “I am assured by the RBI and all the banks that enough liquidity will be provided to brokers and market players. Liquidity will not be an issue,” Chidambaram said.

Liquidity has been one of the biggest worries for the market after the recent Reliance Power public issue received bids for over Rs 7.5 trillion. Investors are believed to have written out cheques for about 30 per cent of that amount and had no cash to meet margin calls from their brokers.

Margin trading takes place when investors trade shares without paying the full purchase price. Instead, a margin or a percentage is paid as collateral that has to be topped up if the share price falls.

Brokers had no choice but to sell shares that they had bought on behalf of their clients to meet those margin requirements with the selloff triggering a slide in stock prices.

Reports late tonight said some investors in the Reliance Power IPO had instructed their banks to stop the encashment of their cheques but this could not be independently confirmed. Investors have been betting on making a huge gain when the Reliance Power issue lists, but that looks less likely given the current state of the market.

Another bad hair day for India’s bourses meant that almost Rs 4 trillion worth of investor wealth disappeared. “My advice to investors is to stay calm,” Chidambaram said.

The Fed rate cut has sparked hope that the worst is over. Shahina Mukadam, head of research at IDBI Capital, said almost all sectors had corrected and a near-term rebound was likely in oil and gas, telecom and banking stocks.