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We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.
The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.
These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.
When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?
Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.
Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.
Home / Markets
Tuesday, May 06, 2008
Uptick
Wall Street Defiant in the Face of $122 Oil
Matt Egan
FOXBusiness
Wall Street closed higher on a day when oil prices were stuck at $122 a barrel and Goldman Sachs forecasted $200 a barrel in the not too distant future.
Today's Market
The Dow Jones Industrial Average rose 51.29 points,
or 0.40% to 13020.83, the Standard & Poor’s 500 index gained 10.77 points, or 0.77%, to 1418.26 and the Nasdaq Composite
Index picked up 19.19 points, or 0.78%, to 2483.31. The consumer-friendly Fox 50 rose 3.84 points, or 0.38%, to 1004.01.
Thanks to an afternoon turnaround, the Dow erased losses of more than 100 points and closed the day in the green.
Aluminum giant Alcoa (AA) climbed 3% and insurer AIG (AIG) rose 2.1% to lead the blue-chip index on Tuesday.
The Nasdaq Composite performed better than the broader market, with Yahoo! (YHOO) rising 5.3% on speculation about
its future.
Much of Tuesday's turnaround stemmed from the market's ability to absorb bad news, especially from the financial sector, which opened the day sharply lower but closed higher. Several companies were influencing the sector: Fannie Mae (FNM) revealed a $2.2 billion first-quarter loss, Swiss banking giant UBS (UBS) posted an $11 billion loss and Merrill Lynch (MER) reported a 69% increase in so-called "Level 3" assets, which are notoriously hard to price and even harder to sell.
"It's pretty amazing that we are even up today... This market is pretty resilient," Alan Valdes
of Hilliard Lyons told FOX Business.
Energy stocks led Wall Street on Tuesday after crude hit another new all-time record of $122.73 a barrel. Energy titans Chevron (CVX) and ExxonMobil (XOM) gained about 1% on the day. Crude closed up $1.87 at $121.84 a barrel in New York.
Wall Street doesn't normally rally on days when oil prices spike because of the negative effect it has on transportation stocks like JetBlue (JBLU) and United Airlines (UAUA) and on consumer spending, which has already been hurt by rising food prices and tumbling home values.
The
spike in oil prices could be nothing compared to a prediction by analysts at Goldman Sachs (GS), who said crude could
reach between $150 to $200 a barrel within the next six to 24 months, according to Dow Jones.
With no major economic
reports due out on Tuesday and the next batch of corporate earnings not set to be released until after the closing bell, Wall
Street initially focused on the disappointing news out of the financial sector.
Shares of both Fannie Mae
(FNM) and Freddie Mac (FRE) opened the day sharply lower but then recovered and closed with big gains. Fannie Mae,
which is a government-sponsored mortgage company, reported a loss of $2.57 a share, compared to estimates from Thomson Reuters
for a smaller loss of 81 cents.
Fannie Mae said the mortgage market will continue to worsen this year before it
gets better, now expecting home prices to decline between 7% and 9% in 2008. The company also cut its dividend and released
plans to raise $6 billion in capital by selling new stock
In Europe, Swiss bank UBS (UBS) said it plans
to cut 5,500 jobs, or approximately 7% of its workforce, after it wrote down about $19 billion in assets and swung to a first-quarter
loss. The bank also said it plans to sell $15 billion of Alt-A and subprime assets to investing firm Blackrock (BLK).
Shares of UBS fell 1.6%.
Corporate Movers
Yahoo! (YHOO) Chief Executive Jerry Yang was more open to a deal with Microsoft (MSFT) in an interview with Reuters on Monday. "If they have anything new to say, we would be open. ... I am more than willing to listen," Yang told the news agency. Talks fell apart between the two tech giants on Saturday and Yang has been under pressure from Yahoo shareholders who think he should have agreed to a deal. Shares of Yahoo jumped 5.3%, a possible indication of renewed optimism a deal will get done.
Merrill Lynch (MER) said
its Level 3 assets increased to $82.4 billion during the first quarter from $41.5 billion at the end of the fourth quarter.
Because there is barely a trading market for these assets, they are considered very difficult to buy, sell or price. Many
of these Level 3 assets are complex debt securities that often include risky subprime mortgages. Shares of Merrill slumped
3% earlier on Tuesday but then recovered to close flat.
D.R. Horton (DHI), the nation's largest home builder,
rose 5.5% even after it revealed a loss of $1.31 billion in its fiscal second quarter. Revenue declined 38% to $1.62 billion
but did top estimates from Thomson Reuters of $1.36 billion.
Sprint Nextel (S) is considering spinning
off or selling its Nextel unit. If sold, it would be only three years after Sprint bought Nextel for $35 billion -- and an
acknowledgement that the acquisition has been a failure. No deal is imminent, the Journal said, but the fact that Sprint is
considering selling Nextel could make the telecom more appealing to Deutsche Telekom (DT), which is reportedly interested
in acquiring Sprint.
Wachovia (WB) revealed that it lost almost twice as much as it originally said in the first quarter. The nation's fourth-largest bank now said it lost $708 million, up from its original disclosure of a $393 million loss. Wachovia announced the change after reviewing its life insurance portfolio.
Hess (HES) jumped
7.9% to a 52-week high thanks to upgrades from Goldman Sachs and Fitch Ratings. Fitch upped the oil and gas company's debt
ratings to "BBB" from "BBB-" on its improved operational performance. Goldman upgraded Hess to a "Buy" rating from "Neutral"
and put the stock on its Americas Buy List, according to Thomson Reuters. Goldman cited high crude prices and "an enticing
exploration program" as potential catalysts to drive the stock up to $150 per share.
Legg Mason (LM) dropped
10.3% on a $250 million loss in its latest quarter. The second-largest publicly traded U.S. investment manager's results were
impacted by one-time charges. Legg Mason said it plans to raise $1 billion by selling a special class of stock, which will
be priced at $50, a discount to the stock's closing price on Monday.
Walt Disney (DIS) closed 1.3% higher an then jumped higher in after-hours trading after it beat the Street with its fiscal second-quarter earnings and revenue.
Molson Coors (TAP) jumped 7.4% to a fresh 52-week high after the brewer beat the Street with a first-quarter profit of $37.1 million. The company's adjusted-earnings of 32 cents per share and 10% rise in revenue beat estimates from Thomson Reuters.
World Markets
The Dow Jones Euro 50, the 50 largest companies of Europe, fell 27.07 points,
or 0.70%, to 3845.08. London's FTSE 100 fell 0.30 points, or 0.00%, to 6215.20.
France's CAC 40 Index lost 22.44 points, or 0.44%, to 5040.92 and Germany's DAX fell 34.98 points, or 0.50%, to 7017.10.
In Asia, Hong Kong's Hang Seng Index gained 78.18 points, or 0.3%, to 26262.13. Japan's Tokyo Stock Exchange was closed on Tuesday.
Market Snapshot
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