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Coordinated Rescue Strategies
By: Dr. Charles Lieberman
Date: 10/20/2008
Policymakers are rapidly closing in on strategies to restore healthy credit markets. The key decision was taken by the Europeans to invest capital directly into banks at the preferred stock level, without diluting common shareholders. This recapitalized their banks, without sending the message to investors to avoid these institutions because they could lose any investment they might make. The United States adopted this model last week, putting $125 billion into our 9 largest banks, and the Dutch followed suit by recapitalizing ING this weekend. With government dollars about to start buying depressed assets, the gradual recovery in credit market should continue. This will also provide the basis for a turnaround in stock prices.
Problems remain. The severe disruption of the financial system is discouraging investment and spending by businesses and consumers. So, the economy will weaken further. And this calls for stimulative policies around the world to promote stronger economic growth. And, indeed, central bankers are reducing interest rates. Moreover, liquidity is being added to promote better credit market conditions, finally with some success. Libor spreads and commercial paper rate have declined, which indicates that banks and short-term investors have begun lending again. It remains critical that yields and spreads decline further to enable and encourage borrowers to utilize credit to finance spending. This is most critical in our domestic mortgage market. But, the new policies do appear to be working.
One of the classic investment strategies is "Don't fight the Fed". If the Fed decides to lower or raise interest rates to influence the economy, they will ultimately get what they want. That admonition could be broadened to "Don't fight the government". We now have governments around the world recapitalizing banks, adding liquidity, and working in myriad other ways to improve liquidity and promote economic recovery. They may need some time for their policies to work. But a successful outcome is very likely in time. Therefore, it is way too late to sell stocks or high yield debt assets to hold cash.
Markets are likely to remain volatile, at least until investor's frayed nerves calm down. Upcoming economic data will surely be weak, so evidence of a weak economy will remain with us for some months to come. Still, many conditions for a turnaround have been created already and more progress will be made in the coming months.
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