Everyone was watching closely the Fed Reserve , the Central bank of US, to take decision on the lending interest rate to other banks. Pleasantly, for market traders, the Fed reduced the interest rate from 5.25 % to 4.75% and Dow Jones reflected the decision by closing some 2.51% higher than the previous close and other Asian markets followed the trend.
However, the question still remains whether the interest cut is appropriate to remedy the sub-prime fever in US. Wikipedia explains ” Sub-prime lending is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history”.
Many major banks of US , Europe and Asia were directly or indirectly involved in sub-prime and suffered heavily. The present interest rate reduction is to help the banks to obtain money from the central bank at lower rates.
Most of bankers has appreciated the cut. But there are still some concerns about the cut. Read the article by Ajit Dayal explaining the sub-prime issue. In the next article he is concerned about the interest cut.
Can any central bank allow its larger banks to fail or be in trouble? Well, under Paul Volcker, the Fed Chairman in 1980 it was possible.
Citibank nearly sank and its stock price was US$ 1 and priced for bankruptcy before the famous Saudi investor (Prince Alwaleed bin Talal) rescued it. But Paul Volcker was a bartender from the days of the black and white movies. Like our own V P Singh, he did not care for the might or reputation of anyone. If you made some silly financial bets and you were wrong, Mr Volcker let you suffer for it. When the US was going through a housing boom in 1980, Mr Volcker did what all central banks should do – he cut that boom to size by raising interest rates to 21% (yes, 21%) in USA. That killed the demand for housing, hurt the US economy big time, killed any inflationary pressures but probably laid the ground for the next, largest and most sustainable expansion in the US economy. By raising interest rates, banks went bust, home building companies went bust, Wall Street was dead. Mr Volcker kept on chewing his cigar and kept on throwing the drunks out of the bar.