Friday, August 17, 2007

Global Equity Markets Panicked, Fed Signals US Bail-Out

The stock chart above is clear evidence that The US Federal Reserve Bank yesterday told the managers of its largest financial institutions, presumably over lunch, that they would step in to halt the market's slide by:

1) dropping margin requirements on options, futures, and index funds from 50% to 15%;
2) directly buying highly leveraged options, futures, and index funds to force the purchase of their underlying stocks;
3) dropping interest rates.

This is exactly what the managers wanted to hear, and it looks like they spread the word. Benchmark stock averages like the Dow Jones came back like Lazarus from the tomb to make back a 340 point deficit in little more than the final hour of trading. This is the stuff of market legend, and a mathematical event of a lifetime. A two-day chart of the more broad-based Standard and Poor's average of 500 stocks is attached above, which records the slide and places the late rally in perspective. This is the picture of a market in panic, with bankers finally pulling out every stop they can think of to get it to level out. Which it did. The last half hour of trading was the steepest rise I ever remember seeing. The line on the chart is nearly vertical.

Yes, I am assuming the Fed is engineering a bail-out based on limited data. Yet I also know the assumption is correct because the amount of confirming information is so voluminous. The far more pressing question are, for which I don't have any confident assumptions and little confirming information: will the Fed's intervention package
work? And for how long?

The answer to those questions will have a huge impact on almost every single person reading this post. Anyone who has a pension, who receives a Social Security payment, who owns stock or bonds, who is indebted, who holds the debts of others, who pays taxes, who has a mortgage, who has a job. Who has parents or children, who eats and breathes. If your house is paid off and you have fifty or more pounds of precious metals stashed away, or if conversely you are homeless and are reading this over a public library's internet connection, don't sweat it. It's only central banking, publicly-traded capitalism, and post-Keynesian economic theory on trial.

George Soros likens the modern global financial system to blood flowing through a body's organs. New York is the heart, London is the lungs, Tokyo is the liver, Hong Kong the pancreas, and so on. In his mental model, places like Thailand and South Korea are somewhat less essential extremities, and when the vital central organs are threatened, the extremities, much like in a human body, tend to be starved of blood first. The Fed's move yesterday didn't immediately get blood going back to the extremities. I'm checking weak pulses right now.

Asia continued its white-knuckled blood loss today. I forget which organ South Korea might be, but yesterday it fell by almost 7%, its biggest one-day decline ever. It dropped by a further 3% today. Asia's largest market, Tokyo, dropped by 5.4%. Kuala Lumpur was down 5%, Mumbai down 2.3%, Shanghai down 2.28%, Manila down 2%. Thailand, which took steps to become more independent of Western monetary policy, only dropped half a percentage point.

European markets just turned upwards. As I write this, London suddenly turned up from down 1% to up 3.3%. France and Germany are following suit. And my assumptions about the Fed dropping interest rates were confirmed in real time. The Yahoo headline reads, "Fed Turns Around Stock Markets."

Honestly, I hope it's true. God help me, but I hope the party doesn't end with a bad bang. Still, there are consequences of trading one bubble for another. In the last week, well over a trillion dollars of new credit was injected into the financial system, that is to say money was created electronically and given to banks, in many instances to buy securities no one else wanted and to redeem debts. Normally, this would be called a "massive bail-out," yet that term is deemed too harsh in these polite times to apply.

The immediate consequences of bailing out bad decisions by bankers and lowering interest rates will be a quickening of inflation, or dollar devaluation. The longer consequences of juicing the market and dramatically lowering margin requirements will be that next time, the blood may well stop flowing entirely. It is axiomatically believed now in US economic theory that the Great Depression could have been avoided if the Fed had more quickly stepped in to not just drop interest rates, but to provide direct stimulus by printing massive amounts of money and forking it over to buy more stock. That proposition is now being tested, and its outcome will be an authoritative lesson referred to through the unfolding century. The lesson, as far as I can see, will be that sticking already over-heated asset markets into the microwave is a truly bad idea.

(Update: The Dow opened 125 points up off the bell. Love that juice! Now it's up 269 points. Now 287, all in the first 4 minutes. Pass the jug, baby. Pass the jug.)


HopeSpringsATurtle said...

Jolly Roger over at Reconstitution has a related post you may be interested in. Nearly everything you write makes either my brain or my heart hurt but I thank you nonetheless.

MarcLord said...

Well I would like to make something not hurt! Seriously, a lot of this post could be summed up as: Fed Plays With Fire Again. Thanks for the Jolly Roger linkie.


Arkady said...

The Babbitt Individualist welfare queens are getting their little tooshies powdered by dear old Uncle Ben, eh? Thanks for the rundown on this. It's a great post with a sober perspective.

A friend sent me a video of that spastic dude, Cramer, shrieking on television. I was really hoping they'd haul him off for waterboarding, just to shut that horrible mouth of his.