Financial Crisis 101 - 10/15/08

PHILADELPHIA - October 15, 2008 - If you thought the market was primed to keep soaring after Monday's 900+ gain in the DOW, you were apparently being a touch naïve.

Lest we forget, the economy has some severe, fundamental problems, and investors were reminded of that today with the release of the news that retail sales went down 1.2% last month, and that was the largest monthly decline in two years. And while sales were down, core wholesale prices were up. Translation: we're afraid we're either in or headed toward a recession.

The Wall Street quotes the managing director of a Richmond, Virginia brokerage house: "Now we're dealing with the real impact" of the credit crisis. "We don't yet know what that is because this situation is so unprecedented. Every road sign has been obliterated.

We also heard today from the Chairman of the Federal Reserve, Ben Bernanke. His message was at once sober, and at the same time hopeful. Bernanke said that it will take time for the economy to recover. These are his words, "stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away."

Bernanke made the point that the housing crisis will continue to hold back the economy, but he insisted that the country's economic ills go beyond subprime lending. Again here are Bernanke's words, "an under pricing of risk, excessive leverage and the development of complex and opaque financial instruments" have been feeding the crisis.

This may be an unfair interpretation, but to me, that's wonk-speak for greed.

On the hopeful side, Fed Chief Bernanke said that with all the moves made by Congress, the Treasury and the Fed in recent weeks, they now have the tools to fix the financial and credit market crisis.

He of course was referring to the bailout plan, and the 700 billion dollars to back it up, new rules for the FDIC, plans for the government to buy bad debt from the banks, and plans for the government to purchase commercial paper, which is the lifeblood for businesses, large and small.

He also made clear distinctions between the current crisis and the Great Depression as if to say, don't worry about that. What Bernanke would not say is if the United States is already in a recession. That's especially interesting because the President of the San Francisco Federal Reserve Bank, Janet Yellin, told an audience last night, "Indeed, the U.S. economy appears to be in a recession." Then she said, "This is not a controversial view." Indeed, it's not a controversial view among many economists, some of whom have been saying that for months. But it's the first time we have heard that word used by an officer of the Fed, and it's a word that the Fed doesn't like to use. It is fascinating that Bernanke refused to comment today on Yellin's remark from last night.

So let's peek at some important numbers that might be a tad difficult to understand, but really hold the key to getting out of this credit crisis.

As we have said before, most of the extraordinary steps the federal government has taken are designed to get the credit markets moving again. That means the banking titans like Citigroup, Bank of America and Morgan Stanley have to start lending money to consumers and businesses, and perhaps even more importantly, to each other.

Obviously, you don't want to lend money to someone you think might go belly-up, and that's been one of the major problems. The government is banking on the idea that an enormous infusion of cash into the banks' coffers will give everybody a degree of confidence that they'll start lending to each other again. That's why the government is buying 250 billion dollars in the banks' stock.

So how can we tell if it's working? Well, there's something called Libor, which stands for the London overnight banking rate. It's the interest rate that banks in many countries, including the U.S. charge each other. On Sept. 15th, the 3-month Libor rate, the rate banks charge each other for a 3-month loan, was 2.82%. Last Friday, it was 4.82%. The good news is that the Libor was down to 4.55% yesterday.

Obviously, Libor has a long way to go to reflect a return of confidence to the credit markets, but it is a tick in the right direction. One reason Libor is so important is because it's often used to calculate adjustable rate mortgages. So when banks are nervous, Libor goes up, and homeowners with ARM's have to pay more on their mortgages. And that brings was back to square one: the relationship between the deteriorating housing market, the economy at large and the financial crisis.

So if you want to know if your tax dollars are helping to solve the mess we're in, keep track of the Libor rate. You can do that by CLICKING HERE.

Jim Gardner

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