Thursday, October 16, 2008

Wall Street Slides (Again)

Well, it looks like Wall Street's big gains on Monday (on the order of nearly 1,000 points) have been completely lost over the last couple of days, as the Dow lost over 700 points yesterday and continued dropping this morning. What happened to the euphoria that followed the Treasury's announcement that they'd begin investing in bank stock? Apparently the big boys on Wall Street realized that the bailouts are only staving off a worse crisis and that the real economy is apparently entering (or is already in) a severe recession. In addition, the credit markets (which lie at the heart of the present crisis) have not reacted as well to repeated action by the Treasury as hoped: markets are improving only on the margins. Inter-bank lending rates are inching down. So are the rates on commercial paper, which are like short term IOUs businesses use to manage their cash flow. Spreads on default insurance policies known as credit default swaps have also edged lower.

But as a general matter, the credit markets haven't had the thaw that policymakers had been hoping for. The yield on long-term Treasuries, which are used to set the rates on many fixed mortgages and are considered the safest of investments because they are backed by the U.S. government, are up to 3.98 percent. The average 30-year fixed mortgage rose to 6.28 percent Wednesday, according to Last week, it was 5.82 percent.

"We will continue to use all the tools at our disposal to improve market functioning and liquidity to reduce pressures in key credit and funding markets," Bernanke said. "Stabilization of the financial markets is a critical first step, but even if they stabilize, as we hope they will, broader economic recovery will not happen right away."

Uncertainty is pervasive. Despite the investment and promised investment of hundreds of billions of dollars into banks and savings institutions around the world, the tight credit markets have yet to substantially loosen:

On Tuesday, the Treasury formally announced that it would be injecting $250 billion into thousands of the nation's banks. The Treasury is going to buy stakes in the banks in order to restore confidence in the markets and convince the banks themselves that it was safe to start lending again.

The program, which will begin this week, is meant to be a straightforward way to beef up thinning bank reserves. Many banks have been running on the cash equivalent of fumes because of their bad bets on mortgage-related investments. The concern about reserves is one of the reasons banks have been loath to lend to one another. They have been worried that once they lend out money, they won't get it back — a mindset that has frozen the world's credit markets. In spite of the cash infusion and government guarantees of senior debt, that mindset hasn't changed much.

Treasury Secretary Henry Paulson clearly saw such an obstacle coming. On Tuesday morning when he announced the capital infusion plan, Paulson warned the bankers against stashing away the new cash. They need to actually use the money they were getting from the government, he said.

"We must restore confidence in our financial system," Paulson said. "The needs of our economy require that our financial institutions not take this new capital to hoard it but to deploy it."

While the Treasury's program has taken care of liquidity and fears of solvency, just how much banks are in the red — how much toxic debt they are carrying on their books — is still an unknown. It is unclear how various financial institutions will measure delinquencies and write-offs and investors will be wary until that happens.

What will it take to undo the crunch when major economic indicators are negative? Your guess is as good as mine, and there is still much to be resolved before we can even begin to know if we're out of the woods yet.

No comments: