Today the US lawmakers rejected the US700 billion “bail-out” package proposed by the Bush administration. With that the US stock market plummets by about 7%, single largest drop in the last many years. At the same time we hear news of failed banks in Europe which are being nationalized – Fortis Bank, Bradford & Bingley in UK, and HRE in Germany is next line. In the US Washinton Mutual failed by end of last week, and we have Wachovia bought over by CitiGroup. I am very sure that these won’t be the last news that we are going to get.
What’s happening is exactly as I have explained before, “settlement risks”, which seems to be getting even tighter: no banks willing to extend any line to other banks. An almost a total collapse of confidence, which drive liquidity almost totally dry. It also seems that any amount being thrown in by Central Banks (which it seems that globally that’s whats being done), are of little effect to ease the problem, since any amount thrown in, will be kept by the Banks to themselves to fend off impending runs. It is just like throwing things into a sinking hole, you never know when it will fill up.
Now come the question, what will happen next? It seems clear to all that somehow the US will get a bail-out package done, albiet, a slightly different version sometimes within this week. In the meantime, it will be a real-time “stress test” that bankers always talk about to the maximum (“the stress tests shows that even such and such happens – this investment products will not fail”). Under this scenario, the US stock markets will tumble down on a roller coaster and drag along the global markets with it; as the “stress-test” continues, many more banks and institutions will fail – being taken over or nationalized of some sort. So far we have not seen losses of confidence by the Global “Sovereign” investors yet, such as China Central Bank or the Middle East funds, dumping US treasury bonds. I can bet that despite all the things said, their nerve is under severe tests as well. Despite all of these, I do not think that we are at the risk of total economic meltdown. Globally, there is enough money to go around and economically speaking, the real sector are still generally robust. One of the final result that I am sure of is that the US Banks and financial institutions global dominance is almost over.
Finally, just to answer one curiosity: why US700 billion? and is it enough to solve whatever problems that exists? The answer to both: ambiguous. The closest answer that is logical is that that is the amount that will get the “settlement” risks uplifted; another answer is that it represents 5% of total US mortgage outstanding (US14 trillion); and so on. Will it solve the problem? Nobody knows, as the whole measure is more of confidence building or “strong signal” to the market to get back into working order. As I explained above, it is a sinking hole that you want to plug rather fast, but you can’t never be sure how.
For now, at least our economy and markets, looks better then them; and may God continue to keep it so.