But after a thoroughly enjoyable evening dining with Marian and the great Harinder Chahal, I come back home to find this NYT headline staring me in the face:
Talks Implode During Day of Chaos; Fate of Bailout Plan Remains Unresolved
When the economy is on the verge of utter, Depression-level collapse, the last thing you want is some salient public event to panic everyone into thinking that everyone else is panicked, thus causing everyone to pull their money out of the system. It's a collective action problem. So words like "chaos" and "-plode" in the morning headlines do not bode particularly well.
Moreover, it is not a good sign that the level-headed authorities that are supposedly piloting us through these troubled waters are doing things like entreating House Speakers on bended knee and pleading with them not to blow things up:
In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.
“I didn’t know you were Catholic,” Ms. Pelosi said, a wry reference to Mr. Paulson’s kneeling, according to someone who observed the exchange. She went on: “It’s not me blowing this up, it’s the Republicans.”
Mr. Paulson sighed. “I know. I know.”
Before tonight, I thought there was an air of cautious optimism that some kind of package--however suboptimal--would be agreed upon that would stave off financial collapse. But it seems like that has been replaced with something far more ugly, visceral, and frightening: panic. It's palpable. It's in the language people are using. "Madness", says Krugman. "This sucker could go down", says Bush. Bailout plans are in "disarray", says WSJ. And Drudge? "BREAKDOWN" (although, it should be noted that there are no siren animated GIFs--close shave there). And on top of all this, Washington Mutual failed and was bought out by JPMorgan.
Of course, all this is just one layman's gloss of the whole thing. Hopefully I'm mildly embarrassed tomorrow and nothing extraordinary happens. But I have the sinking feeling that tomorrow will soon have the word "Black" attached to the front of it.
PS: Apparently, the key figure to keep an eye on is not the stock market but the so-called "TED spread". This measures the difference between the interest on 3-month Treasury bills (T-bills) and the 3-month LIBOR. Let's see if I understand this well enough to explain it coherently:
A T-bill is a security that the federal government issues as a way of borrowing money from the general public: you pay, say, $1000 for the T-bill, and the government agrees to pay you back $1100 in three months. T-bills are considered one of the safest possible investments, because they are backed by the federal government--the government, of course, being the only player in town capable of raising funds by coercive force (taxes) or, if it comes down to it, by simply printing more money. Interestingly, the interest rate of the T-bills is determined by a regularly held auction, so that it is constantly fluctuating depending on how much demand there is for people to lend money to the government (or, put another way, how much demand there is for T-bills). If there are lots of people who want to lend to the government, then the government can command a lower interest rate for itself, because lenders will be undercutting each other at the auction with lower and lower interest rate offers. If there aren't a lot of people who want to lend to the government, it will be forced to borrow at a higher interest rate. If investors don't have confidence in private institutions, then they tend to flock to the safety of federally-backed T-bills, driving down the T-bill interest rate.
Meanwhile, in just the same way that the government borrows money from the general public (including big banks), big banks borrow from other big banks. The LIBOR is the average interest rate at which this interbank borrowing takes place.
The upshot of all this is that, when times are good and investors are very confident in the private banking system, then banks will consider loaning to other banks to be as safe a bet as loaning to the federal government--and so the interest rates will be about the same for lending to each, and the difference between the rates (the TED spread) will be small. However, if there is little confidence that banks can repay their loans, then no one will want to risk lending them money unless they get a juicy interest rate in return (e.g., I'm not gonna take the risk of lending First Shitty Bank International a billion dollars unless there's a significant upside in it for me--like, say, that First Shitty will borrow from me at high interest rate). And so the average rate at which banks lend to each other--the LIBOR--will be higher.
To put it all together: if there's high confidence that private banks can repay their loans, then these banks can demand interest rates as low as what the government demands. However, when confidence in the banks' ability to repay is at an ebb, borrowing banks cannot command a good interest rate from lending banks, and so the average interest rate of interbank loans (LIBOR) rises. Moreover, since investors are flocking to the federal government (since it's too risky to lend to private banks), the interest rate of T-bills goes down. The rising LIBOR and falling T-bill rate means a higher TED spread.
The TED spread, then, reflects the amount of credit that is available: a high TED spread means there is not that much credit around (i.e., not much money available that can be borrowed), and a low TED spread means that credit is plentiful (i.e., it is easy to get an affordable loan).
The big danger is that credit will "freeze up"--become unavailable--and that all of the parts of the economy that rely on there being credit--people being able to buy houses and cars, businesses being able to stock inventory and keep operations going during a revenue slump, financial institutions being able to pay investors who unexpectedly want their money back--will simply stop. And this will cause a negative feedback loop of investors pulling their money out of the system (i.e., liquidating their assets--i.e., selling their assets--i.e., turning their assets into cash), leading to a flooding of the market with assets, which will cause the value of the assets to plummet (too much supply, not enough demand), which will cause the financial institutions--whose net worth is tied up in the assets--to have even more losses, which will make confidence in these institutions' ability to repay their loans sink even lower, which will make interest rates even higher (and thus, credit even scarcer), and so on, until we wake up and Depression II is upon us, and a huge chunk of the economy has gone out of business, and unemployment is at 25%.
Phew! So, I'm not sure if all that is correct. It is my best understanding of the whole situation, and I am, I hasten to remind you, a layperson when it comes to this stuff. But I think the basics are there, and in any case, I recommend keeping a tab on Paul Krugman's blog tomorrow, as he will no doubt have some kind of analysis of that all-important TED spread figure.
Oh, and by the way: here is what the TED spread actually looks like. We're already way up in the 3% "credit hell" zone--let's see what tomorrow brings.
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