Crisis far from over, even with emergency cut

By Jennifer Ablan - Analysis

NEW YORK (Reuters) - The Federal Reserve's huge emergency rate cut on Tuesday did little to allay fears of a brewing U.S. recession even though panic selling in global stock markets has moderated.

The three-quarters of a percentage point cut in the Fed's short-term interest rate target, to 3.5 percent, has helped restore some investor confidence, reflected in the rebound in many overseas stock markets.

Even so, many investors continue to brace for a recession. Major U.S. stock indexes closed down more than 1 percent after the Fed's aggressive move, although they recovered from severe declines shortly after the market opening.

"It's simply now a consumer-led mild recession that will show up in the first- and second-quarter GDP numbers in the negative -- with a minus sign," said Bill Gross, chief investment officer of Pimco, or Pacific Investment Management Co.

The slide in housing prices and the risk that consumers will close their wallets, if they have not already, are the bigger worries, he said in an interview with Reuters.

"That is what the Fed has to turn around," Gross said.

That is not all that needs to be turned around.

"We have massive excesses from the recent expansion, and its associated bubbles, which take more than a few weeks to work out," added Robert Arnott, chairman of Research Affiliates LLC, a Pasadena, California-based investment management firm.

Already, the ripple effect from the slump in housing and consumer sectors has been far-reaching and recognized globally.

The market capitalization for MSCI's All Country World Index fell $979 billion on Monday. Since Thursday, the MSCI All Country's market cap has plunged by $1.189 trillion.

At the root of investors' anxiety are subprime mortgage loans made to borrowers with shaky credit. Delinquencies are still rising on subprime mortgages, and defaults are piling up at record rates as home prices continue to sink, weighing on consumers' desire to spend.

But strains still exist in the U.S. credit and banking markets, triggered by a lack of confidence in financial markets as subprime mortgage defaults soared.

Losses on U.S. subprime mortgage investments continue to show up on bank and fund balance sheets around the world, making credit more difficult to obtain.

In fact, the price of loans in the U.S. secondary market declined further on Tuesday, making it harder for banks to offload nearly $200 billion in loan commitments on their balance sheets.

The LCDX, an index of 100 loan credit default swaps, briefly dipped as low as 92.25 cents on the dollar before rebounding to about 93.62 cents after the Fed's surprise interest rate cut.