So the $700 rescue plan finally passed this afternoon. The entire process was a disgrace. While various members of congress extracted over a billion dollars in extra goodies over the last two weeks for their votes, investors lost well over $1 trillion of IRA and other tax-deferred investments as the market plummeted. That was money we planned to retire with and live out our years but instead most of us now face the prospect of working for several more years just to get back to where we were. But it doesn’t stop there.
A lot of damage has been done to our economy in those two short weeks. The bond markets almost ceased to function, short-term credit rates rose to levels that have prohibited borrowings by corporations worldwide. It was an immense shock to a global economy that was already reeling from dozens of body blows. So the question we are all asking is what happens now?
The stock market sold off on the news. That is not a good sign. Far more important however, will be the reaction in the credit markets. Will this plan inject confidence in lenders? We will need to watch the bond markets for an answer.
Look to the LIBOR (the London Interbank Offered Rates of interest) spreads. They need to narrow. These are the rates at which banks are willing to loan other banks unsecured funds in the London wholesale money market. Think of it as the credit market’s thermometer. The higher that rate rises the worse the patient’s fever. In the past few days the patient (economic activity) has been all but comatose.
Many market observers believe that no matter the result, the stock markets will trend lower. The economy, they argue, has now been pushed over the edge into recession. The only question remaining is how bad the recession will be.
I believe that the bail-out is not a cure-all. The markets can move higher but investors will need to see evidence that this plan will work. To me, the plan is simply the end of the beginning and additional measures will be required over time. Yes, readers, I am talking about a Plan B and maybe a Plan C after that. At the same time, I would expect the Federal Reserve and other Central banks to ease interest rates and continue to flood the financial system with money. Only then will we have a chance to combat the huge de-leveraging process that is going on in the U.S. financial system.
When you read “deleverage” think deflate. It is the opposite of inflation. Money is disappearing by the billions on a daily basis in the form of all this toxic paper that is now worthless. That has a deflationary impact on the economy like a scarcity of grease in a gear box. The gear box is our economy. Unless those gears are re-lubricated, they will begin to stutter, chatter and smoke. Before long the gear box will catch fire and stop. Right now we are in the stutter, chatter stage.
As for me, I’ve got some egg on my face after my call two weeks ago that we have reached an interim bottom see (“We’ve made a Bottom, Buy on the Dips”). It appears that we have not– mea culpa, mea culpa, mea maxima culpa. It will take time to restore confidence and in the meantime the markets will remain volatile.