Bernanke, Paulson: Giving Traders What They Want

Traders got what they wanted: 1) Bernanke sounded like Don Kohn, and 2) Paulson is taking the reigns and indicating he is trying to stop the subprime crises from spreading.

1) Bernanke: In his speech last night, Bernanke made it clear he was worried about the direction of the economy. He said the labor market was weakening and that "With respect to household spending, the data received over the past month have been on the soft side."

What has got traders talking this morning is that Bernanke not only made a case for a 25 basis point cut in rates in December--it was widely believed that that would happen, despite the reticence of some Fed members--but that he may have laid the groundwork for a 50 basis point cut if the data indicated further deterioration.

Tony Crescenzi at Miller Tabak and others have pointed to the closing sentence: "In making its policy decision, the Committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially."

The word "materially" implies a more aggressive stance if the data changes.

2) Paulson: Treasury Secretary Paulson has been meeting with loan servicing companies and other executives in the mortgage industry to work out a plan that would extend lower, introductory interest rates on home loans before they reset at higher levels. There is hope that some kind of formal announcement can be made in a week or two.

This is what activists have been calling for: a concerted attempt to stop the contagion. Alarm bells went off on Wednesday when Wells Fargo announced they were taking a $1.4 billion provision for possible losses on home equity loans.This was not subprime; there were millions of "piggyback" loans done in the last few years, where an original mortgage was combined with a home equity loan, often at 100% of the value of the house.

If high loan to value ratio loans start deteriorating, and banks will not refinance loans that have high loan to value ratios, we could be in much bigger trouble.

This is an important day: the Fed and the Executive Branch are clearly working to resolve the problem.

Questions? Comments?