CONTAGION

The loss of confidence in financial institutions, as of yesterday pm, was complete. Today’s globally coordinated package aims to insert trust into a world wide financial web that has been completely without it. In addition to the Fed, the European Central Bank, the Swiss, Canada, China, Hong Kong - all cut rates drastically. The UK announced their rescue plan which among other things partially nationalizes major banks. German, Ireland and Greece pledged to guarantee savers deposits. Iceland took over two of its largest banks. Spain agreed to bail out its banks by taking on $68 Bln of their assets. My goodness.

What was at first a liquidity problem, triggered by the US mortgage mess (and key within that, the failure of Fan/Fred) has now become a world wide solvency crisis. All the world’s major banks are intertwined and in incredibly complex ways, many of these unregulated and hidden. Now funding has evaporated; no one trusts anyone else not knowing what’s on their books. Interbank lending, the life blood of the system, is unsecured. If one bank lends to another it relies (or relied) on trust that it will get it back with interest. Central banks have been flooding the markets with cash but to little avail. Banks simply hoarded anything they can get their hands on because of fear of counter party risk. Hoarding cash to rebuild one’s balance sheet quickly becomes a habit, a state of mind. This is one reason part of today’s UK package in effect guarantees banks’ debt to, hopefully, restore confidence and get banks lending to one another again.

Contagion has moved quickly in the US from the financial to the non-financial sector. The so-called commercial paper market provides corporations with short term funds - anywhere from a few days to a few months. This is how they fund their day-to-day operations (not capital operations). This was a well established (over 90 years), deep and liquid market. Last week this market became frozen. Nobody wanted to take any risk at all, not even to GE. So with the recent announcement the Fed is now backing that market too, meaning the Fed is in the direct business of making loans to the private sector. This is a stunning development.

Look at this as a very large wicked loop. Weakness spreads from the financial arena quickly to consumer and capital spending, from a global slowdown to US exports (until recently a real strength), promoting further and more intense declines in employment, then pressuring income, consumers and lenders, on and on.

Robert Craven