Today's unprecedented decision by the world's central banks to cut interest rates around the globe is exactly what the market needs. Unfortunately, it looks more like admission of what's going wrong in the global financial system than a true solution.
Panic selling on Monday and Tuesday that sent the Dow below 10,000 was caused by consensus on Wall Street that the government's $700 billion bailout plan simply didn't address fears that the credit crisis is spreading like wildfire outside of America's borders. That hasn't stopped. If anything, it's gotten worse this week. Banks simply aren't lending. Investors are willing to hide out in treasuries even though they're offering no return.
The problem is, rate cuts alone don't put a value on mortgage assets or send capital directly into the banking sector. Rate cuts begin the process, but with fear in the markets at record levels, traders could simply take the action as a last-ditch (and possibly belated) attempt to get in front of an almost insurmountable loss of confidence.
Some quick reactions, and some plans for what to do next:
Carl Weinberg of High Frequency Economics says the Depression playbook has been opened:
The objective of policy—actually, the only thing policy makers can hope to do—is to take steps to ensure that the event is dampened so that only a recoverable downturn of national economies is suffered. Otherwise, a dip into an unrecoverable—or at least, prolonged and deep—depression is the alternative.
The playbook is this then: Push interest rates as close to zero as the central bankers dare. Other than Japan, there is still room for more rate cuts, and an urgent need for them according to our understanding of how the world works. Next, pump as much safe money into the hands of non-bank private sector. Yes, this means central bank credit to business, and maybe even to individuals. Banks have ceased to function as financial intermediaries, and the central banks have to go around them to keep the economy lubricated. Finally, massive fiscal stimulus is needed, immediately. While normal rules of public finance tell us that deficit spending is bad, the alternative to massive public support of private demand right now is a lot worse.
Nouriel Roubini tells Henry Blodget the rate cut is helpful but not enough. He calls for a huge $300 billion (a new New Deal) increase in government spending to cut out the coming shortfall from consumers.
David Malpass at Encima Global says the next step could see Treasury stepping in to recapitalize the banks:
I expect the Treasury facility to evolve into buying preferred stock. Treasury may make this announcement today.
- If Treasury decides to buy preferred stock, it will be a very positive evolution of the bailout plan. I disagree with the view that it should be interpreted as a partial nationalization of banks. Instead, it is a stop-gap measure during a crisis.
- It will add capital to banks to partially offset the arbitrary mark-to-market decapitalization of recent months. This is a critical step in getting banks to lend.
That doesn't mean hopes for an eventual recovery in stocks are completely dashed. Analysts are tiptoeing around the possibility that stocks are setting up for a bottom simply based on the theory that markets are well within historical bear territory and the huge liquidity injections provided by central banks will have an impact. But there's no concrete evidence global rout in stocks is over yet.
Coordination among central bankers is a hopeful sign. They'll need to continue working together to keep this crisis from getting worse.