Stocks posted their biggest one-day gain in five years yesterday, after the Federal Reserve said it would dump $200 billion in cash into the frozen mortgage-backed securities market.

Essentially the Fed is going to lend money to Wall Street in exchange for the toxic debt that no one else will take—privately issued, AAA-rated, mortgage-backed securities and those guaranteed by Fannie Mae and Freddie Mac—in a bid to stop the downward spiral of forced selling caused by margin calls.

The Wall Street Journal spreads it across four columns above the fold on page one:

The offer amounts to a surgical strike at one of the most worrisome new developments in the global credit crunch: A wave of investor selling of mortgage-linked securities. The heavy selling is driving up mortgage interest rates, dealing a fresh blow to the flagging housing market, and threatening the nation’s economy by making credit harder to come by.

The Financial Times says its pretty close to the ol’ direct government bailout:

The initiative takes the US central bank a step closer to the nuclear option of buying mortgage-backed securities in its own right, although it stopped well short of such an extreme action.

Bloomberg reports that this may just the beginning for this specific program, which itself is just the latest in a series of Fed cash drops since August. The WSJ on C1 says those have totaled a trillion dollars already and that the market euphoria, which reversed yesterday’s losses for Fannie, Freddie, Bear Stearns, and others, may by short-lived.

The New York Times leads its front page with the news and warns that it may not be enough to stop the spiraling downturn:

Despite the staggering sums being offered by the Fed over the past week, some analysts warned that the new infusion of money might not be enough to fill the hole caused by the losses on ill-conceived mortgages during the housing bubble.

Quote of the Day:

“They are essentially creating a $300 billion bank out of nothing,” said Lou Crandall, chief economist at Wrightson ICAP, a financial research firm.

But while the Fed’s moves may relieve short-term cash problems, Mr. Crandall said, “it doesn’t solve the fundamental issue, which is the decline of capital in the banking system.”

MarketWatch quotes a prominent analyst saying the latest move may have been precipitated by the problems at Bear Stearns (basically a bailout of the bank), which this week denied that it was facing cash problems.

Downgrade Delayed

Bloomberg has an important, if difficult-to-read, story about how credit-rating firms are delaying downgrades of tens of billions of dollars of mortgage-backed bonds. In our reading of the story, it seems Bloomberg is saying Moody’s and Standard & Poor’s aren’t downgrading any of the AAA-rated securities that are used in calculating the ABX index, which is one of the only sources for what prices are in that market.

We think it’s implying that the firms are afraid to write down those specific bonds because that would push the index down further, causing investors to have to write down their investments because of so-called mark-to-market rules. It mentions a 2006 Deutsche Bank issue, for instance, that is still rated AAA despite having defaults on 43 percent of the mortgages that were bundled to create the bond.

The prospect of losses may be holding the ratings companies back, said Frank Partnoy, a University of San Diego law professor and former Morgan Stanley banker who has been writing about the impact of credit ratings companies since 1997.

“If the 800-pound gorilla moves, it’s going to crush someone, so it’s not going to want to move,” Partnoy said. “They know they will trigger a price collapse. They are understandably reluctant.”

More reason to kill off this conflict-laden credit-ratings business model.

More Trouble in the Citi

The FT reports that Citigroup is having to bail out six internal municipal-bond hedge funds to the tune of $1 billion, as they became the latest to be caught up in the margin-call rout. These funds are being hurt by the problems in the municipal-bond markets, though Citi says they’ve eased in recent days.

Citigroup’s latest troubles highlight the risks run by the many Wall Street groups that have set up or bought hedge funds in an attempt to boost trading profits and capture high fees from investors.

Since the onset of the credit squeeze, Citigroup has had to rescue another in-house hedge fund and several investment funds by injecting capital and moving $49bn in assets on to its balance sheet.

The NYT quotes a Citi spokesman in full spin mode saying the bank views the bailouts as “attractive investments.”

Domicile Delinquents

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.