Now that the Fed effectively has interest rates to zero, what does it do as the economy worsens.?One Fed official says that policies need to be set up so that rates are effectively below zero.

According to Reuters, Charles Evans, president of the Chicago Fed said, Quantitative easing, a way to flood the banking system with large amounts of money, "is a way to mimic below-zero rates and provide support to the economy." Usually that would involve the agency buying up huge amounts of assets from banks.

There is another potential alternative, although it has never been tried. If the Fed plans to spend tens of billions of dollars buying assets, why not put the money into the system by offering the capital to banks at a negative .5%? The reasoning against this is the the Fed would be paying the banks interest on the money they borrow instead of the tradition model of the banks paying the Fed.

The odd program might have two effects. The first would be to increase bank lending to business and consumers. With the Fed paying interest for bank borrowing, the risks of bank lending would drop. The other by-product is that banks could rebuild their balance sheets damaged by losses from investments like mortgage-backed securities, with capital being underwritten by the Fed.

It's crazy, but it might work.

Douglas A. McIntyre is an editor at 247wallst.com.

The Federal Reserve will buy up to $500 billion in mortgage-backed securities early next year. This marks the first move by the agency that may actually help turn the credit markets around quickly.

The Fed has tried cutting interest rates to 0%. This does not seem to have improved lending by banks. It has also allowed banks to use its emergency lending window to trade securities with questionable value for cash to build their reserves. This has not done much to improve bank balance sheets, earnings, or lending.

Finally, the Fed is headed back to the major cause of the current market's troubles, the housing market. The Fed cannot go into the marketplace and refinance every single mortgage that is in default or underwater -- in terms of its relationship to the actual equity in houses. But by buying the securities, it can improve that value that is attached to that part of the economy -- the MBS.

Most of the hundreds of millions of dollars in bank losses over the last few years were due to the falling value of MBSs. With housing prices still falling, the value of underlying derivatives is still in trouble.

According to Reuters, "When they are buying along the lines of $80 billion to $100 billion a month, if they're going to do it in six months, they have to buy everything they can get their hands on," said Kevin Cavin, a mortgage strategist at FTN Financial in Chicago.

It is the first government program that will help both home owners and banks at the same time.

Douglas A. McIntyre is an editor at 247wallst.com.

As the U.S. market wraps up a wild day in which central banks cut rates in unison, one sector has no doubt at all about where it wants to go -- down. Three leading insurance companies have lost as much as a 28% of their stock market value in today's trading alone. How so? As I posted, insurers are the next part of the financial foundation to crumble due to mortgage-backed securities (MBS) gone sour.

Here's the latest insurance industry carnage:

• XL Capital (NYSE: XL) -28%. The property-casualty insurer holds $29 billion in asset-backed securities such as MBSs and collateralized debt obligations (CDOs), 330% of its shareholders' equity.
• Met Life (NYSE: MET) -27%. This life insurer announced plans to sell 75 million shares and to fire an unspecified number of employees. It also expects to earn between 83 cents and 93 cents per share -- way below analysts' $1.44 forecast.
• The Allstate Corp. (NYSE: ALL) -21%. This property-casualty insurer holds $83 billion in fixed income securities such as MBSs, 421% of its shareholders' equity -- and the $22 billion in Level 3 -- difficult to value -- fixed income securities exceed its $19.7 billion in capital.

I expect this problem to affect every insurance company to some extent. Will the $810 billion rescue plan relieve these institutions of their bad investment decisions? We might know in a year. Until then, look out below.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

Research firm Punk, Ziegel & Co is putting a "buy" rating on Citigroup (NYSE: C). The research firm feels that the bank is the best proxy for investing in the global investment industry and that its write-downs are secondary. Quoted by MarketWatch, the firm said "The stock allows one to invest in the world's financial growth better than any other company. Others perform in one part of the financial sector or operate in one portion of the world."

That comment may be akin to saying that if you are going to drown in quicksand, you might as well find the best quicksand available. Citigroup is hardly a strong investment and the fact that its business operations are global and that it operates in many sectors has nothing to do with whether the bank can do well over the next year.

Citigroup is being scuttled by huge write-offs in its mortgage-related investment portfolio. Earnings from other divisions in the company are not likely to offset this and the bank may have to raise more capital. The resulting dilution could certainly drive the price of the company's stock down. There have also been comments from Wall Street that the big bank may have to cut its dividend. That is likely to make it much less attractive to a certain category of "yield-minded" investor.

Citi shares could be hit by more write-offs and the need to bring in a large sum of new capital.

That hardly makes it a "buy."

Douglas A. McIntyre is an editor at 247wallst.com.

The Dow lost 237 points today according to The Associated Press. The stated causes?

• The HSBC bailout of $45 billion worth of SIVs
• Citigroup Inc.'s (NYSE: C) announcement that it would fire as many as 45,000 people
• The Fed's announcement that it would inject $8 billion worth of liquidity -- in the form of short-term loans -- into the financial system

The daily explanations of market movements are not really that meaningful. But I am inferring three very disturbing messages from these market moves:

• There are serious unrealized losses in the banking system as a result of their holdings of Collateralized Debt Obligations (CDOs) and Mortgage-Backed Securities (MBSs) that nobody wants to buy.
• The banks may not have enough capital on their books to take the big bath write downs needed to account accurately for these bad assets.
• The banks and the government are hoping that if they can stall for time long enough, the problem will take care of itself.

The market will keep dropping until these messages are no longer true. This could take years to clear up.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Citigroup shares.

Merrill Lynch (NYSE: MER) may have used deals with hedge funds to delay reporting its exposure to risky mortgage-backed securities to investors, according to a report in the Wall Street Journal (subscription required)today. If this is sounding more and more like the Enron story to you, that's because it is.

Enron found ways to hide its derivatives (and that's what these mortgage-backed securities are) by setting up shell companies so the debt could be held off its books. Details about Merrill's moves are becoming clearer as part of an SEC investigation now in the works regarding how Merrill Lynch valued its mortgage securities and how it reported those holdings to investors.

Initial reports indicate Merrill Lynch sold commercial paper to hedge funds with promises of buying it back a year later and guaranteeing the hedge funds a minimum return. If this is true, the primary difference between Merrill's tactics and Enron's would be that Enron set up its own shell companies while Merrill used hedge funds. Merrill Lynch refused to comment on any specific transactions mentioned in the Journal's story.

It's a bit more than 20 years since the Dow fell 508 points, or 22.6%, in a single day. With Asian and European markets down a mere 1% to 4% today, it does not look like we'll have a repeat of that 23% decline today. What's happening in world markets? According to the New York Times, Hong Kong fell 3.3%, Japan tumbled 2.2%. South Korea was down 3.25%. In Europe the early news was not as bad -- London's FTSE 100 was down 1.4%, the German DAX dropped 1.3%, and Paris slid 1.8%.

Twenty years ago, the CEO of the company I worked for sent one of my colleagues to figure out good stocks to buy -- considering the market plunge an opportunity to buy good stocks at a discount. It turned out that he was right. The cause of the crash was found to be related to simultaneous computer driven-selling that somehow took the rationality out of stock valuations.

But will today's potential plunge also turn out to be a buying opportunity? The answer depends on your time frame and which stocks you buy. It's never clear to me why markets go up and down although "explanations" get printed every day. But it could be that the big reason for the selling in global markets is fear. In particular, investors fear that the U.S. has unleashed a subprime mortgage-backed securities (MBS) financial virus that is sucking an unknown -- but enormous -- quantity of credit out of the global financial system.

Hank Paulson's floundering effort to rescue the world from this MBS viral epidemic is not inspiring confidence. So I would not be eager to rush out and buy stocks in this market. Unlike the computer-driven selling of 1987, the economic costs of MBS's financial "innovation" are still too difficult to count.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

It is an extremely odd concept. Take a bank's mortgage-backed securities and pool them with those of others, then offer loans to keep the new pool solvent.

Yet, such a plan may be in the offing. According to The Wall Street Journal [subscription required]: "In a far-reaching response to the global credit crisis Citigroup (NYSE: C) and other big banks are discussing a plan to pool together and financially back as much as $100 billion in shaky mortgage securities and other investments." The paper adds that the Citigroup plan would create a "superconduit," a fund backed by some of the world's biggest banks that would issue short-term debt and serve as a buyer of securities tied to shaky U.S. subprime mortgages and other assets currently held by funds affiliated with the participating banks.

The U.S. Treasury Department is trying to help the idea along by hosting some of the meetings about the plan. It is obviously in the federal government's best interest to have the banking credit situation improve, especially if the banks can solve their own problems.

The program does seem a bit perverse; banks bailing themselves out by putting together weak assets and selling them at a discount, and at the same time, supporting them with more short-term bank money.

The sub-prime problem has already created strange bedfellows. Bank of America (NYSE: BAC) has made a large investment in Countrywide Credit (NYSE: CFC). At first, the deal looked like a steal for the big bank, but as Countrywide problems mounted and its stock fell, BAC may have come to regret the move.

That is the core of the issue. Will banks that pool weak assets and support them with short-term loans come to regret their own actions? They may if the mortgage disaster gets a lot worse a lot faster.

Douglas A. McIntyre is a partner at 24/7 Wall St.

The nation's fourth largest brokerage firm, Lehman Brothers (NYSE: LEH), reported its August 31st quarterly results this morning. Investors began to breathe a sigh of relief as the numbers beat Street's expectations posting $1.54 earnings per share versus the expected $1.43 EPS. Earnings were 3% lower from last year's results, which were accomplished in an accelerating environment.

Lehman Brothers acknowledged a $700 million hit from "substantial value reductions" in mortgage-backed securities. The investment banking and retail brokerage fees were up 3.1% for the quarter and total revenues were $4.3 billion. Lehman Brothers stated that 53% of its revenue totals came from overseas activities, helping to absorb mortgage-backed securities losses.

Lehman Brothers, once known as a pure trading house, has diversified its revenue stream substantially. Coupled with more than 50% of its revenues coming from international sources, the giant firm has shown it can weather the credit-storm.

The stock is up over 4% today on the relief factor. The next few days will see Bear Stearns (NYSE: BSC), Morgan Stanley (NYSE: MS) and Goldman Sachs (NYSE: GS) report their August results as well. If Lehman Brothers is any indication, investors may again feel these stocks have come down too much and begin nibbling away on the buy side. The only remaining significant issue is the credit markets and if they have indeed calmed down. If so, the leverage in the business model of the major four firms could begin to re-accelerate earnings in 2008.

Georges Yared is the CIO of Yared Investment Research and the author of Baby Boomer Investing...Where do we go from here?

In a stunning move this morning, Reuters reports that the Bank of England is bailing out England's Northern Rock plc (LSE: NRK), which had the biggest share of the UK new mortgage market in the first half of 2007.

The strange thing about this bailout -- in the form of an unspecified emergency loan from England's version of the U.S. Federal Reserve -- is that Northern Rock forecasts a profit for 2007. Specifically, it now expects 2007 pretax profit $1.1 billion, albeit 23% below analysts' current consensus forecast.

Given this expected profit, why would Northern Rock need a bailout? The mortgage company depends on wholesale financing as the source of cash to lend out to borrowers. And given the weak state of the market for buying packages of mortgages it and its peers originate, it appears that Northern Rock faced a short-term liquidity crisis. The funds it's receiving are at a higher, penalty, interest rate.

NRK shares, already down 50% in 2007, plunged a further 20% in early trade. If there's anyone who knows how wide and deep the problems lie in the shaky global financial network built on mortgage-backed securities, they're not saying.

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter.

American Home Mortgage (NYSE: AHM) options indicate Panic as AHM sells off 24%. The company invests in mortgage-backed securities and mortgage loans. AHM is recently down $2.72 to $10.89 on unconfirmed credit line chatter. AHM announced on 6/28/07 it will take substantial charges for credit-related expenses in the 2nd quarter and withdrew its 2007 earnings guidance. AHM call option volume of 10,996 contracts compares to put volume of 29,783 contracts. AHM July straddle is priced at $2.25. AHM August put option implied volatility is at 183, August put implied volatility is at 205; above its 26-week average of 47 according to Track Data, suggesting larger price risks. AHM puts are priced higher than calls on AHM being difficult to borrow. July options expire tomorrow; July 20th.

Daily Option Update is provided by Stock Options Specialist Paul Foster of theflyonthewall.com.