In the Wake of the Failed Bailout Bill…

Writing for the Wall Street Journal, Min Zeng and Mark Gongloff report that in the wake of the failure to pass the bailout bill, overnight lending rates are ratcheting up–a trend which was already well on its way before the vote.

But, as has often been the case during this crisis, credit markets are singing a different tune. Overnight dollar Libor rates more than doubled to 6.875%, as banks hoarded cash for the quarter end amid signs the financial crisis was spreading. It’s more than a little ironic that while investors are buying banks’ stocks — shares were up sharply across the sector — banks themselves were unwilling to buy each others’ shortest term debt. Banks are so desperate for funds that they paid 11% for $30 billion in overnight funds from the European Central Bank, up from 3% just Monday.

Sure, a second round of dollars from the ECB and a 28-day injection of funds from the Fed helped calm the worst panic (indeed, the ECB’s $50 billion offer drew just a bit more than $30 billion in bids, and the rate fell back to 0.50%; while fed funds are now trading at 3.0% rather than the 7.0% high we saw them at earlier), but we’re a long way from normal. Lena Komileva, economist at broker Tullet Prebon, notes the premium for overnight liquidity is “out of control,” making it hard for central banks to instill confidence in the future.

In short, credit is frozen, in part because institutions are hoarding liquidity for the end of the quarter. Monday’s Epic Fail on Capitol Hill would seem to be hurting too — except credit was worsening even before the $700 billion bailout bill died, notes Brian Reynolds, chief market strategist at WJB Capital.

Not a good sign at all. In the meantime, Tyler Cowen breaks out the best and worse case scenarios. Here’s the bottom line on the BEST CASE scenario:

The American economy is in recession for two years and unemployment does not rise above eight or nine percent.

It’s not really clear right now what’s going to happen out of Washington in the wake of yesterday’s vote. If I had to bet, I’d say that we’re probably looking at a much smaller appropriation–on the order of $150 billion or so–and a promise to revisit this after election day. In the meantime, I would expect the FDIC to step up with some more guarantees–they can, for instance, guarantee short-term interbank loans. (On a side note, can I just say that the FDIC has done a magnificent job handling the sales of Wachovia and WaMu? Right now those look like they’re going to remain pretty smooth, and no taxpayer dollars required.) I also wouldn’t be surprised to see the Fed continuing the trend of injecting more capital into the banking system. Less likely, but within the realm of possibility, is for the Fed’s printing presses to kick up a notch to make some debt worth a little less.

FILED UNDER: Congress, Economics and Business, US Politics, ,
Alex Knapp
About Alex Knapp
Alex Knapp is Associate Editor at Forbes for science and games. He was a longtime blogger elsewhere before joining the OTB team in June 2005 and contributed some 700 posts through January 2013. Follow him on Twitter @TheAlexKnapp.

Comments

  1. the most important reason the bailout failed is because the voters opposed it in a landslide.

    The architects of the bailout failed to make their case to the American people.

  2. Davebo says:

    (On a side note, can I just say that the FDIC has done a magnificent job handling the sales of Wachovia and WaMu?

    Actually in WaMu’s case it was more of a giveaway than a sale.

  3. jagorev says:

    Wait, did the Wall Street Journal just use “Epic Fail”? That is awesome.

  4. Steve Plunk says:

    With the closing bell less than an hour away the Dow is now up nearly 500 points. Why?

    It could be the panic from yesterday has subsided and cooler heads are back in charge. Perhaps the talk of raising the deposit insurance limits has calmed the markets. Maybe bargain hunters couldn’t resist some of the prices.

    The initial jump in futures yesterday and the actual prices at the opening bell is likely the cooler heads. Many old time Wall Streeters are saying we’ll weather this just fine. The jump later in the day is probably the announcement by the SEC that rules for pricing loans and mortgage backed securities would be reviewed and likely changed.

    Changing those rules would instantly revalue many of these “bad” securities and turn balance sheets into much more attractive documents. The present rules forced banks to value these at market rate in a market that didn’t want to buy them. Now they may not have wanted to sell either but they had to report them at a lower value and that screwed up their balance sheets. This change will renew faith in the banks and stabilize the system.

    It’s funny how once things got serious all the different agencies and congress got serious as well. For gosh sakes why can’t they be serious all of the time?

  5. Steve Verdon says:

    Wait, did the Wall Street Journal just use “Epic Fail”? That is awesome.

    No kidding, now I’m waiting for the phrase, “Don’t mix guns”.