Why won’t your bank lend money to other banks, or to many homeowners, car buyers, small businesses or big businesses right now? Because there isn’t much of a secondary loan market at the moment. Or a commercial bond market. It’s all one big constipation problem in our credit markets.
(cont.)
“There’s so much liquidity in the system — unfortunately, the liquidity is not opening up lenders at all,” said Kim Rupert, managing director of global fixed income analysis at Action Economics. “It’s the epitome of credit turmoil. There’s too much fear in the market. Everybody is hoarding their cash, hoarding their reserves, not trading funds with each other.”
For big companies to operate and grow, they need to borrow money. Typically, they do this by selling short-term and long-term bonds in the credit markets. Right now, the short-term debt markets are at a standstill; the long-term debt markets are a bit more functional, but rates are very high.
Companies in search of cash do have an alternative — they can go directly to the bank. But banks have their own problems with capital right now, so a company trying to get a loan has about as much luck as a person trying to get a mortgage.
Those with clean credit histories will likely get loans, but at high rates. Those with spottier credit histories might not get loans.
“In a good case scenario, the economy is slow. In a bad case scenario, there are massive bankruptcies,” said Axel Merk, portfolio manager at Merk Funds.
“The problem is, the general public doesn’t understand this. Maybe we need to see a few payrolls fail at a few companies before they realize,” he said. “This has a very direct impact on Main Street.”
Banks are funny institutions, and I speak as a retired lawyer who used to work for a few banks. When the good times are rolling they push their people hard to make loans, and all the fee income that is generated. That’s because they can book the loans as assets and the fee income (which they might very well have loaned also to their borrower) as income that goes directly to their bottom line. It’s a double win.
And in addition, when the Wall Street firms were securitizing loans for them they could sell their portfolios into the secondary loan market while retaining the right to service the loans and make a fee for said services. This caused them to make some really stupid loans when there wasn’t any effective oversight by regulators. But when there’s any report of trouble, the old bank anus tightens up tighter than a cork in a bottle.
Guess what situation we’re in now? The central banks are pouring funds into the financial markets but to little if any effect. The banks are afraid to make loans in an uncertain economic climate because they can’t sell them to reduce their risk. With the housing market continuing to drop like a stone, and with no one able to assess the creditworthiness of their own portfolios, much less those of the other institutions that they normally deal with, they have done the old classic pucker the sphincter maneuver. And until they hear that the credit markets are functioning normally again, that’s the way it’s going to stay.
Why do you think the bailout will help substantially clear up the credit markets? We’ve been trying smaller versions of the bailout for a year and it hasn’t worked.
http://www.nakedcapitalism.com/2008/09/bailout-scare-mongering-another-bank.html
Because what we have is a fear problem right now, one that has been exacerbated by the sudden pronouncement od doom by Bush and Paulson (which the financial world heard loud and clear even if many other Americans did not), yes, but we can’t walk back to go and start over. What was a slow burning fuse of a problem has now exploded. Government can’t do much in the short term but try to change the mindset of the credit markets and its major participants, banks, investors and other lenders. I have no idea about the substantive benefits of the bailout, but from a purely psychological standpoint, lenders, bond traders, etc. have to believe that the governments of the major economic powerhouses, and in particular, the US government, is willing to act to prevent a meltdown in the credit markets. Whatever we pass now can be altered in the future by the next Congress, but if we don’t pass something now the crisis in confidence that will generate will only add fuel to the fire.
And yes, Bush is to blame for trying to pull a 9/11 stunt with Paulson and cram down a poorly thought out plan on Congress without any input from either the Republicans or the Democrats. This time being the boy who cried wolf so many times backfired on him. But who go with the President you have in a crisis, not the one you wish you had. The current bailout plan was flawed but a flawed plan is better than doing nothing for those reasons.
I like Obama’s idea of increasing the FDIC insurance limit to 250,000. That could be added on. I’m sure there are other ideas that have great merit if we had the time to assess them properly. But we don’t.
The stock market rise today tells me that investors think they’ll get another vote on a bailout plan by the end of this week. And if they don’t, or the vote goes down the same way as the last time? You tell me what will happen? I don’t want to find out, frankly.
But doesn’t the huge debt of the US Government itself a source of the fear? That is: Government pumps in money, government goes bust as foreign banks call in loans. Money is now worthless, US defaults, chaos.
The US won’t default but…when pushed to the wall they’ll crank up the printing presses and monetize the debt.
Yes, I just looked into it and realized that the solution would be to pay off the bonds by printing staggering quantities of dollars to generate massive inflation.
But will the US credit rating be downgraded? I know I heard rumblings about that a year or so ago.
It’s still AAA but I read a couple of stories recently that McDonald’s bonds were considered safer than US treasuries.
We do have a fear problem. And thank you for approaching the subject in a reasonable manner. I trust these types of analysis much more than the scaremongering and calls to “fix” or “save” the economy. It sounds to me like you are taking this approach, which I respect, although disagree with: http://economistsview.typepad.com/economistsview/2008/09/how-much-will-i.html
Also, the stock market is a side show. It has been long behind the credit markets and was due for a correction: http://bigpicture.typepad.com/comments/2008/09/all-time-high-o.html
This liquidity injection has very little effect on the stock market. The day after the bailout was announced the market went up by about the same amount as the proposed injection: 700 billion. The bigger factor on the markets is that Bush and the GOP, after years of blowing smoke up our asses, have finally panicked. The crew on MSNBC has spent a year telling us the fundamentals are sound and Paulson and the CEO president will fix things if they just reduce taxes and provide a little more liquidity to the system.
That’s all gone now. The emporer has no clothes. And Bush and the GOP are playing politics trying to turn this into their advantage. And the Democrats are once again playing defense because they are so scared of their own shadow. The Democrats are pinning their hopes on a short-term solution and taking responsibility to “save” the econmy. Sounds like a fool’s mission to me.
Anyway. We’re screwed. That’s why I stopped going long U.S. equities last year (I’m a dreaded short seller) and put my retirement into safe vehicles that my depression-era grandparents would have invested in. We’re just individuals and we have to look out for ourselves first and foremost. Obama will not be saving us.
You mean CNBC, as opposed to MSNBC?
From the article you linked:
“The implosion in the CP market, which is truly dangerous, is completely the result of the Treasury dropping the ball. Is this a bug or a feature? If the Treasury is trying to keep panic up so it can get the bailout bill passed, that is simply heinous. But the lesser charge, that they have neglected this task by virtue of being distracted, is criminal neglect. Take your pick.”
This to me, is the most pressing issue. Commercial Paper greases the wheels of out economy. I also agree with that article that solving this is mostly about securing MM funds/accounts. The other thing I’d like to know was part of the plan is setting some sort market-controlled value to these toxic assets.
Without that it seems like we are just catching pieces of shattered glass and treating them like diamonds.
The rest seems to be about easing the pain of folks who made this bed and don’t feel like laying in it. I’m one of them, and I don’t think that’s the best idea unless that is the method to attain a respected valuation, which should liquify other credit markets and salve bankers fears..
Am I crazy for thinking we can live through a few years of total market shite – and it may even be ‘good’ for reducing dependency on the government/markets?
I guess things will be a lot worse for city dwellers. I have employment, food, energy all within walking distance. Even if I lost my job, I could live on fish and cunning. Old folks, the disabled, the young and Manhattanites, etc do not. It’s for them I guess I still support doing SOMETHING that will give even the bad actors the room to try to dig out of this..
I kinda wish I had some bailout cash right now – what a buy opportunity!
You’ll die of heavy metal poisoning from all that fish! But seriously, a city is a better place to be when times are really tough. There are soup kitchens. There is some measure of law and order. There is work, even if it’s under the table, ill paid, and intermittent.
To get by in the countryside, you need land and farming knowledge and equipment. You must be well armed; others will envy your winter supply of turnips. I’d get a bunch of chickens, which can feed themselves in the weeds and give you eggs to eat and sell; I’ve known poor countrypeople who’ve lived on that, along with winter money from Christmas trees.
It’s unusual to be within walking distance of anything when you live in the country; it’s common in the city.
But I’d be dead without my meds, or wish I was, so I won’t have to worry about the fine points for long.
The subjective “fear problem” problem is based on the objective “debt problem.” These banks are deleveraging. They’re sucking up every dollar they can to bring their leverage down to acceptable levels to control the risk to their balance sheets. They do consider lending to each other as risky–the trust issue–but they also have very real balance sheet problems that magnify the risk.
edwards, deFazio, progressive caucus offers alternative plan
Too late. McCain already has a plan, and it’s a lot simpler than what the Progressive caucus proposes. A lot simpler.