Ben speaks and the market actually rallies!

I woke up yesterday to more bad news: the overseas markets were taking a beating as investor anxiety over the credit crisis and upcoming earnings season were gripping traders from Tokyo to London. The domino effect started in the US on Monday after negative news about the mortgage lenders hit the wires. When nerves are raw and emotions are high, problems can catalyze downside action in a matter of minutes, but in this environment, it feels like seconds.

The trouble started after a Lehman Brothers report estimated that mortgage lenders Fannie Mae and Freddie Mac could be forced to raise approximately $75 billion ($46 billion for Fannie and $29 billion for Freddie) in capital, diluting existing shareholders, if a proposed accounting rule change were enacted requiring companies to move certain off-balance sheet securities onto their books. These were the investment vehicles that were used to sell off, or securitize debt instruments such as mortgage securities. Even without the rule change, some analysts believe that additional capital will be a necessary ingredient for each company’s ability to survive the housing crisis and the associated credit losses. Still, it was the Lehman report on Monday that did the most damage, as both companies fell to their lowest levels in more than 14 years--FNM dropped more than 16% to $15.74 and FRE fell nearly 18% to $11.91.

The selling continued overnight and into Tuesday, as the news sunk in about the two mortgage giants. To add insult to injury, the FDIC announced that it would bar IndyMac Bancorp from making new mortgages, which further fanned the flames for jittery financial sector investors. Japanese markets tumbled Tuesday after a one-day respite, and resumed their two-week slide, sending the Nikkei 225 Stock Average 2.5% lower to close at 13033.10, after falling below the 13000 level intraday for the first time in nearly three months. The results were similar across Europe and within a couple of hours of the US opening, things looked pretty messy.

That’s why the timing of Fed chief Ben Bernanke’s comments at a mortgage-lending forum hosted by the FDIC was particularly fortunate. Bernanke described a plan to expand the central bank’s authority over financial firms and “In doing so, we aim not only to make the financial system better able to withstand future shocks, but also -- by reducing the range of circumstances in which systemic stability concerns might prompt government intervention.”

Given the news swirling on Tuesday morning, investors could be forgiven for being hopeful that Mr. Bernanke would succeed in making “the U.S. financial system itself more stable.” After his comments, the market opened to the upside and traded higher throughout the day, with the S&P 500 closing up 1.7% on the day. Some of that action occurred on the back of nearly $6 drop in crude oil, but for a change, Bernanke’s comments definitely got the day off on the right foot. Of course a day does not make a trend, but it sure is preferable to the alternative!