The Fed's modest little market rescue effort, and what comes next

From this morning's W$J, an account of what New York Fed President Tim Geithner did last week:

Particularly at times of stress, what the Fed says can be almost as powerful a weapon as what the Fed does. So Mr. Geithner, whose job makes him the traditional liaison to Wall Street, turned to a convenient forum, the Clearing House Payments Co., which is owned by a group of banks and operates much of the plumbing of the nation's financial system. To avoid the inevitable headlines -- and comparisons to the 1998 rescue of Long-Term Capital Management, when financial executives were summoned to the New York Fed's fortress-like headquarters -- Mr. Geithner sought a 15-minute telephone conference call.

On the call were commercial bankers who work with Clearing House as well as several top investment bankers, among them Zoe Cruz, co-president of Morgan Stanley; James Cayne, chief executive of Bear Stearns Cos.; Joseph Gregory, president of Lehman Brothers Holdings Inc.; and Stan O'Neal, chief executive of Merrill Lynch & Co.

Joined by Mr. Kohn, but not Mr. Bernanke, Mr. Geithner told banks about the discount-rate cut and said they could wait up to 30 days, instead of just a day, to pay back their discount-window loans. "We will consider appropriate use of the discount window ... a sign of strength," said Mr. Geithner, according to a participant.

...

Another banker participating in the call said of the Fed, "What they came up with is pretty ingenious." Investment banks or hedge funds that hold mortgage-backed securities can't borrow from the Fed directly, but they can bring those securities to banks. In turn, the banks can offer the paper as collateral to the Fed for a 30-day loan.

The Fed "really wanted to drive home the point that if [bankers] were complaining about not being able to borrow money against liquid, high-quality securities -- mortgages -- we have no more basis for complaint. We were all given a clear message," says this banker.

On Friday and this morning, global stock markets have reacted as if the Fed's little intervention solved everybody's problems. But stock markets are just the barometer here. All the action is in debt markets, and the way these credit-market corrections seem to work is that for months and months almost everybody underestimates the extent of the problems and markets are repeatedly surprised by bad news until finally everybody begins to expect bad news and reality begins to surprise on the upside.

There will almost certainly be more bad news in the weeks to come: more hedge funds reporting big losses, more lenders in trouble, etc. But will it be surprisingly bad news?