I find fascinating this entire discussion of whether or not voting down the bailout bill yesterday poses an economic danger to the US. Markos, quoting Davis Sirota, isn’t worried. It’s worth reading what Markos is saying, as I think it represents what many of our own readers believe. But I have to say, I still am worried.
Sirota says that critics are saying that anyone who is against the bill wants to see America go into another depression. Perhaps some are, but that’s not really the point. It’s irrelevant what your motivation is for opposing the bill. All that matters if what the economic consequence is of that position. Markos points to the market being up a few hundred points today, and says this is a sign that all is not lost. But credit markets are still frozen. Practically no one in America can get a loan right now. No one. So I decided to use the Google and find out more about what this credit crunch really means.
But first I talked to our own financial expert, Chris, who told me:
A market moving up as it is today in NO WAY represents a positive long term direction. Often markets that are going down and are about to capitulate will have radical swings up and down before a big bottom. Many called this crazy movement a few weeks ago and I think I mentioned it at one point. It may or may not be the case this cycle but it’s completely wrong, wrong, wrong to say the movement today suggests everything will be OK. Everyone’s anger is understandable, but the bigger issue is lessening the impact of this very serious recession that’s upon us.
Now, for the Google – first up, the Motley Fool:
The best way to measure the health of the credit market is to look at Libor.
So what is Libor?
Libor stands for the ‘London Interbank Offered Rate’ and is the rate of interest at which banks borrow from each other in the London market….
Twenty-four hours ago you could borrow dollars overnight at an interest rate of 2.57%. But since the US rejection, that figure has soared to 6.88%. That’s an astonishing rise and shows how worried people are in the credit markets. Other interbank rates have also jumped although the rises aren’t as high.
High interbank rates matter because they mean that some banks can’t get cash to lend on to businesses and ordinary people. If businesses can’t borrow, some will fold and the economy will head into serious trouble.
In an example of how fragile credit markets have become, the state of Massachusetts yesterday tried to borrow $400 million to make its routine quarterly local aid payments to cities and towns. State treasury officials said the credit markets abruptly froze midday, leaving them $170 million short. The state will have to use its own funds to complete the local aid payments, draining the state’s balance to extremely low levels.
Municipalities, too, are having trouble raising money. Cities are usually considered good bets to pay off their debt, but right now even they’re having trouble. New York recently had to pay an interest rate of 9% on a $75 million short-term debt issue—up from 1.25% at the beginning of September. Other cities, including Denver, have faced similar situations.
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.”
If the credit markets should freeze up–which many say is happening and will continue without massive intervention–everyone that borrows money will face a cash crunch. That means companies that take advantage of short-term loans to get by won’t be able to buy raw materials or make payroll. Even businesses that don’t need short-term capital may defer purchases to preserve capital.
If even banks are having a hard time getting money, what does that say for the small and midsize business?
Banks are reluctant to lend money even to each other. Businesses can’t borrow the cash they need. Without relief, says economist Mark Zandi, Main Street could feel the pain soon.
“We’re gonna see it in the form of rising unemployment, job losses, cut backs, even bankruptcies,” Zandi says.
And if you sense we’re already in a recession, then you ain’t seen nothing yet.
“This would deepen that recession and potentially deepen it to the point whre youwould see the kind of economic deceleration we haven’t seen since the 1930s,” Massoca says.
Because businesses that can’t get access to credit can’t hire workers. And that puts the brakes on the entire economy.
Marginal Revolution (via WSJ)
The best case scenario: The bad banks continue to be bought up, there is no run on hedge funds next Tuesday, only mid-sized European banks fail, money market funds keep on buying commercial paper, and the Fed and Treasury continue to operate on a case-by-case basis. Since Congress doesn’t have to vote for something called “a bailout,” it can give Paulson and Bernanke more operational freedom than they would have otherwise had. The American economy is in recession for two years and unemployment does not rise above eight or nine percent.
The worst case scenario: Credit markets freeze up within the next week and many businesses cannot meet their payrolls. Margin calls cannot be met and the NYSE shuts down for a week. Hardly anyone can get a mortgage so most home prices end up undefined rather than low. There is an emergency de facto nationalization of banks to keep the payments system moving. The Paulson plan is seen as a lost paradise. There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag. The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands. In the very worst case scenario, the Chinese bubble bursts too.