Jeremy Warner's Outlook: All of a sudden, the Fed can do no wrong

Bad-mouthing: Lehman reassures; Bear Stearns: hope springs eternal

Investment bankers always seem to think it is about them. In fact, interest rate policy should be driven by the economic fundamentals, and not market sentiment. There was initially some disappointment on Wall Street yesterday that the US Federal Reserve had cut interest rates by "only" 75 basis points, when the demand had been for nothing less than the full 100 points.

Yet the speed and decisiveness with which the Fed has acted to forestall the collapse of Bear Stearns and underpin confidence in the markets has impressed everyone. Going into the interest rate decision, the Fed's credit was riding high.

After a period when he seemed asleep at the wheel and apparently oblivious to the seriousness of the crisis facing the markets and the wider economy, Ben Bernanke, the Fed chairman, had in the eyes of Wall Street redeemed himself. Like his predecessor, Alan Greenspan, for the moment Mr Bernanke can do no wrong.

Why, he's even had the temerity to defy the financial markets because of fears about rising inflation and refuse to give them exactly what they wanted. What even a few months ago would have been regarded as a sign of denial seems today to be thought of as the actions of a man now fully in control of events. It's quite a turnaround in perceptions, and the Dow surged last night on the back of it.

The cut of "just" 75 basis points seemed like a much-needed return to normality. Anything bigger, and the markets might have thought he was panicking. As it is, the Federal Open Markets Committee still has enough of a sense of perspective to realise that inflation is still a problem. Rate cuts so deep that they might increase it would only raise longer-term interest rates and thereby add to the misery of mortgage holders.

The Fed seems finally to be recovering some of its poise. More importantly, it has realised that interest rates are there to address growth and inflation, not in itself distress in financial markets. Other tools, which are now being amply applied, are available to treat that particular sickness. For the moment at least, the markets seem convinced.

Bad-mouthing: Lehman reassures

With bank shares rebounding strongly on both sides of the Atlantic even ahead of the Fed's rate cut, is the crisis in confidence across financial markets finally starting to ease? So many false dawns have already been hailed in this ever-deepening collapse, that only a fool would pronounce it over on the evidence of just one day of slightly better sentiment.

There are certainly more bumps and traumas to come, yet as I suggested here yesterday in writing about Bear Stearns, we may finally have entered the end game. Support for this view can be seen in results from Lehman Brothers and Goldman Sachs.

Nobody ever doubted the ability of Goldman Sachs to sail through the crisis largely unscathed, yet the rumour-mongering and loss of confidence that did for Bear Stearns was never far from Lehman's door. So intense had the bad-mouthing become that the Fed has had to warn investment bankers to cool it and stop trying to make money out of each other's misery.

Lehman's is another second-tier Wall Street player, and, like Bear Stearns, it has been a big underwriter of mortgage-backed securities. Yet the investment bank's results statement yesterday seemed to lay to rest market concerns over its health.

Lehman's has long claimed that, having nearly gone bust in the Russian debt crisis of 1998, the financial implosion that sunk Long Term Capital Management, it has learned its lesson, and has since prepared itself for the worst that markets can throw at it.

If investors have doubted this, yesterday's results seem to confirm ample defences, with $34bn of liquid assets and a further $153bn of other assets that can easily be drawn on. On the face of it, this doesn't look like a bank which is about to suffer a liquidity squeeze. The results have been harmed not just by writeoffs, but, as you would expect given what's happened, a big fall-off in fixed-income revenues.

On a grander scale, it was a pattern mirrored in results from Goldman Sachs. The results confirm the self-evident – that the age of plenty in investment banking is for the time being over. Returns, bonuses and employment over the coming year will be cut sharply.

Yet Lehman's is at least still standing firm, and likely to remain that way. Whether the same can be said about everyone else is still up in the air. Rumours continue to swirl around UBS, which, for a bank still so dependent on traditional, Swiss, wealth management, is particularly dangerous. For the record, UBS denies any outflow from prime brokerage, and points to figures for wealth management from January showing continued net inflows.

Whatever. Both the Lehman and Goldman numbers demonstrated a degree of clarity which has been lacking to date. Bankers are getting to the stage where they can with some degree of confidence quantify what's out there, and investors may be starting to believe them.

Bear Stearns: hope springs eternal

Is JPMorgan Chase's acquisition of Bear Stearns at the token price of $2 a share quite the done deal it pretends to be? With the shares trading at around three times that amount, there is obviously some residual hope of rivals coming in, or at least of Jamie Dimon, JPMorgan's chairman, being persuaded to pay more. This scarcely looks realistic.

Some of the share price rebound is admittedly down to short positions being closed out, but, as with Northern Rock, there is also lots of hedge fund activity in anticipation of further action to come.

The debate over valuation is eerily reminiscent of Northern Rock too, with shareholders pointing to a book value of way in excess of what JPMorgan is proposing to pay, but JPMorgan, apparently backed by the Bear Stearns board, is arguing that without the support of its balance sheet and the $30bn facility being provided by the US Federal Reserve, the shares would be worth nothing at all.

Technically, shareholders still have the power to frustrate the bid. Out of bloody-mindedness alone, some might take the view that, having lost virtually everything already, they would have little more to lose by putting Bear Stearns into bankruptcy proceedings.

The law in this area is unclear, but it may be possible for the authorities to over-ride the shareholders and enforce a JPMorgan takeover. What's more, the Bear Stearns board has already signed away the rights to its New York building to Mr Dimon in the event of the deal falling apart. A sizeable poison pill has thus been established which would further devalue the bank if it were put into run-off.

There appears no decent prospect of counterbids given the general state of bank balance sheets right now. JPMorgan is one of the very few with the balance-sheet strength to take Bear Stearns on its books.

Barclays, possibly in partnership with private equity, is said to have been in over the weekend exploring the possibility of alternatives, but it seems to have been unable to act with the speed of JPMorgan. In any case, the US authorities might regard Barclays as already too capital-constrained to take on such a potentially massive liability.

As for talk of Joe Lewis, one of Bear Stearns' major shareholders, possibly in conjunction with Jimmy Cayne, the chairman, and private equity investors, forget it. The Fed would never weather such a proposal even if it could be made to fly. What the authorities want is a big balance sheet to underpin confidence, not another leveraged buyout.

The best hope is that Jamie Dimon might pay a little more if only for the purpose of ridding himself of years of vexatious litigation, but even that's a forlorn one.