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Stocks Close Higher on Fed, Lehman and AIG

Published: Tuesday, 16 Sep 2008 | 3:47 PM ET

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By: Jeff Cox,
Special to CNBC.com

Stocks rallied at the close after the Federal Reserve held the line on interest rates and investors were encouraged that Lehman Brothers and American International Group might work out deals to improve their perilous financial situation.

Major indexes took a sharp downturn after the Fed decision, but after digesting a statement in which the Fed hedged on its options for the future, stocks turned positive.

Stocks also were higher on hopes that American International Group would not fail as the Fed was considering a loan package for the troubled insurer. CNBC reported that the Fed could announce some kind of arrangement by the end of the day.

Also, Barclays agreed to buy the broker-dealer business of Lehman Brothers, which filed for bankruptcy on Sunday.

Pimco chief executive Mohamed El-Erian said the Federal Reserve's decision to hold interest rates steady at its latest policy meeting on Tuesday confirms the central bank is focused on massive liquidity injections for calming markets.

Major U.S. Indexes

.DJIA

.NCOMP

.SPX

El-Erian, whose investment firm oversees the world's largest bond fund, told Reuters the Fed avoided a rate cut due to inflationary concerns. It was a sentiment that El-Erian's fellow Pimco executive Bill Gross called "other-worldly."

"In terms of today's policy moves I'd suggest that this statement as it pertains to inflation is clearly other-worldly, meaning some Fed governors are on another planet," Gross said on CNBC. "Because clearly we're in a deflationary environment in all asset classes exemplified by oil in recent weeks and that has the potential to feed into the real economy with significantly negative effects. Now that inflation is no longer the visible enemy it pays to shift the focus to stopping the slide of the real economy via easier monetary policy here and abroad."

The sentiment was shared even by those who thought the Fed made the correct decision.

"While I believe the Fed made the right call on the rate decision ... it is hard to take much comfort from a policy statement that seems so oblivious to recent developments," wrote David Ressler, chief economist at Nomura Securities in New York. In any case, the Fed’s decision can be interpreted as an implicit statement of confidence that it has the tools in place to ensure the liquidity of the financial system.

"By leaving the funds rate unchanged, the Committee also has kept some of its powder dry and ready for use if conditions deteriorate further. The considerable risk that more powder may yet be needed seems to justify this conservative approach."

Watch stock market reaction to Fed decision on video at left.

AIG [AIG Loading... () ] shares earlier tumbled as much as 45 percent as worries grew that the nation's leading insurer would be unable to secure fresh capital after a new round of downgrades. The stock later cut its losses pending news on its future.

Some were predicting that AIG was down to its last day to find capital or face bankruptcy.

"I think they have a day," New York Gov. David Paterson said on CNBC. "We're in the moment right now as to whether or not they can put something together. ... The degree of difficulty is pretty strong." See Paterson's comments in the accompanying video.

Both investment banks and their commercial counterparts had been broadly positive, despite continued concerns over AIG and a disappointing earnings report from Goldman Sachs.

In another big deal, Lehman Brothers [LEH Loading... () ] lost more of what little value its shares had left on news that Barclays [BCS Loading... () ] would be taking over at least part of the company, according to a CNBC report. Trade was quickly halted on Lehman pending further developments on the deal, valued in initial reports at $2 billion.
Richard Drew / AP

Washington Mutual [WM Loading... () ] led bank stocks, surging more than 20 percent at one point on a report that JPMorgan [JPM Loading... () ] was in talks to acquire the Seattle-based thrift.

Also, Merrill Lynch [MER Loading... () ] continued to benefit over enthusiasm over its purchase by Bank of America [BAC Loading... () ], which earlier led Dow gainers but surrendered ground after the Fed ruling.

And Wells Fargo [WFC Loading... () ] asserted its position as one of the large bankers that did not have some the level of credit exposure as its competitors.

But Goldman reported earnings before the bell that fell 70 percent from the previous year to $1.18 a share, compared to $6.13 a year earlier. The earnings beat expectations of $1.71, but continued concerns over the industry sent Goldman [GS Loading... () ] shares sharply lower.