Policy and stock market crashes

These are extraordinary falls in global stock markets, even if they are not - as The Guardian puts it - a "wave of panic selling". Some people may be selling in panic, but there is always a buyer on the other side of the transaction. The proper way to describe today's market moves is that traders have drastically marked down prices. In the past few weeks, governments and central banks have stumbled through a series of measures to try to unfreeze the interbank lending markets. Investors are unconvinced, and are discounting a serious risk of a collapse in output and corporate earnings growth.

It would be foolhardy of me to offer a prognosis for asset prices, but I offer two points on which to close this week.

1. Plans to stabilise the financial system have quite suddenly become more coherent. Unconvincing, uncoordinated and (in the case of unilateral deposit guarantees) rash expedients have given way to what appear to be well-constructed schemes for recapitalising the banks and providing liquidity. Will they work? There is a good chance they will, by providing the confidence in lending that private institutions now lack.

2. Central banks likewise slashed interest rates after the 1987 crash and flooded the system with liquidity. It worked; there was no recession. Today's crisis is more intractable, because the banks are holding assets on their balances sheets that are unsaleable (specifically securities that are backed by US mortgage debt). But other assets are good. In providing liquidity to the financial system, the central banks ought to make it possible to unfreeze the interbank lending market. Commercial banks will once again be able to borrow against the value of those assets. In any event, policymakers have avoided the terrible errors that ensured the Great Crash of 1929 turned into a Great Depression. The Federal Reserve then operated a tight money policy, and exacerbated the crash in the stock market by restricting new broker loans.

It doesn't feel like it; but policymakers have been getting their act together. This did not look likely even a week ago.

Comments

[Eddy Elfenbein]

Oliver - I think you're missing a big point. The market is falling precisely because it believes that the U.S. government, under Obama, will redo the terrible errors of the Great Depression. Obama has talked about higher taxes, more regulation and he's criticized our free trade policies. That's not a good mix.

[Alcuin]

"the banks are holding assets on their balances sheets that are unsaleable"

I thought the problem is that much of these assets were *off* balance sheet. Either way, I would have thought the solution was a thorough audit, and if that requires legislation, so be it.

I understand that while prices have tumbled, volume is low, i.e. no one wants to buy ... yet.

[tamtam]

even if they are not - as The Guardian puts it - a "wave of panic selling"

you might want to look at the Times Online headline today...

[Mark]

Thursday's 7.3% fall on Wall Street, which largely precipitated the 'bloodbath' that hit other markets on friday,followed the lifting of the US ban on shorting certain financial stocks at midnight wednesday (and which has left Morgan Stanley in intensive care). Coincidence ?

[John B]

How much of the "other assets are good? What are those "good" assets? How did the banks acquire the "good assets?" How many of the "good assets" came from now defunct off-balance-sheet entities?