Hard as it may be to believe, credit for yesterday’s astounding 936-point rally in the Dow Jones Industrial Average should be given to the Europeans. In less than a week, they may have succeeded in doing what has eluded both the U.S. Treasury and Federal Reserve: Beginning to restore confidence in global financial markets.
What makes the ideas of Gordon Brown, the British prime minister, and Nicholas Sarkozy, the French president acting as the leader of the European Union—along with those of the leaders of Germany, Italy and Spain—especially potent is how they were able to take decisive steps to try to resolve a problem decidedly not of their own making. They agreed to take equity stakes in their largest banks and, more important, since banks no longer trusted each other’s creditworthiness, offered government guarantees of the short-term loans made by one bank to another in an effort to put some grease back into the frozen credit machinery.
For some inexplicable reason, Paulson, Bernanke et al. have yet to introduce the idea—as the Europeans have done—of offering to guarantee interbank lending for state and federal chartered banks. What are they waiting for?
For a day anyway, the credit markets began to thaw slightly, with the three-month dollar London interbank offered rate, or LIBOR, a benchmark that reflects banks’ borrowing costs to one another, falling to 4.7525%, from 4.81875% Friday. Once upon a time, a month ago, three-month LIBOR was 2.81%.
Meanwhile, Treasury Secretary Hank Paulson and Fed chief Ben Bernanke—from the country to which blame is permanently affixed for creating the crisis—have, to put it charitably, been bogged down in trying to pass and implement a $700-billion bailout package, which, truthfully, has been dead-on-arrival ever since Paulson made his infamous three-page proposal three weeks ago. The U.S. House of Representatives somehow divined this fact when it voted down the bailout bill the first time around, although it’s unlikely the House did so for that reason.
The U.S. debt and equity markets—until yesterday—also had figured out that the bailout, while glitzy, was unlikely to solve the problem anytime soon. The Treasury all but admitted that events were moving too fast for the all-but moribund bailout package when yesterday evening word began leak out that some $250 billion of the $700 billion fund would be used to buy preferred equity stakes in the nation’s ailing banking system—whether the banks want the money or not. The aim was to shore up their balance sheets while not spooking the investors and creditors of any one particular bank.
For some inexplicable reason, though, Paulson, Bernanke et al. have yet to introduce the idea—as the Europeans have done—of offering to guarantee interbank lending for state and federal chartered banks. What are they waiting for? Until banks feel comfortable lending to each other, let alone lending to corporate or individual borrowers, there cannot be a hope of a true recovery from this colossal mess. Starting today, the Treasury should guarantee all short-term loans from one bank to another.
If all elements of a comprehensive plan—of guaranteeing inter bank lending, of making capital injections into banks, of guaranteeing bank deposits of up to $250,000 for two years, of guaranteeing money-market funds up to $250,000 for two years, of amending the bankruptcy laws to permit mortgage debt to be treated like other secured debt, and of suspending for one year the rule that mandatory withdrawals be made from IRAs and 401Ks at certain ages—were put in place, the outlines of a restorative plan would begin to be clear to Americans. And that would really be something to cheer about.