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Short View: Only more pain will resolve the Fed’s little Greek tragedy

The unwinding drama in the credit markets already looked like a Greek tragedy before the appearance, on Wednesday, of a deus ex machina, notes the FT’s John Authers in Thursday’s Short View column. When Greek dramatists could not resolve a tragedy, a god could be winched on to the stage using a crane.

Markets initially treated as divine intervention the news that the Federal Reserve would expand its term securities lending facility to $200bn, and accept mortgage-backed bonds as collateral for up to a month. The move should give the affected players more time to deal with liquidity difficulties.

But within hours, the prices of gold, oil, the dollar and US financial stocks were all roughly back where they had been at the start of trading on Monday.

This continues a pattern. Since the credit crisis began last July, almost all market rallies have come after acts of external, if not divine intervention.

Here are some other dei ex machina, that were once supposed to winch the market out of its funk: the Fed, when it cut the discount rate last August, again when it launched the term auction facility in December, and again with its emergency rate cut in January; the US Treasury and its “super-SIV” plan; the Abu Dhabi Investment Authority and its purchase of a stake in Citigroup; and Warren Buffett with his offer to buy the healthy part of the monoline bond insurers. None of these rallies lasted long.

It remains hard to fault the Fed. Wednesday’s action should help the market’s liquidity problem, caused as banks call in loans. It is appropriate for central banks to alleviate this problem.

The underlying issue is one of solvency rather than liquidity. Many assets are not worth as much as many had optimistically assumed.

Neither the Fed nor anyone else will enter from stage left to sort out this problem. Tragically, the solution will involve some pain.

This entry was posted by FT Alphaville on Wednesday, March 12th, 2008 at 6:55 and is filed under Capital markets. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Mar 15   8:32 Posted by Bear Stearns and Bearer markets « de(e)pre(ce)ssion [report]

    […] In just two days all the Fed’s effort,  injecting $300 bn in overnight, goes burst; as now, at last, all commentators say:  the underlying problem IS NOT ILLIQUIDITY, BUT INSOLVENCY. […]

  2. Mar 12   11:38 Posted by hedgehog [report]

    pegnu:

    re the Sudden Debt link and the ‘ like watching a football game entirely in slow motion ‘ I remember my very first car accident when my car lost traction in heavy snow and stared spinning slowly towards a wall- the result was inevitable and try as I might once the spin had passed a certain early point there was no way I could regain control - everything did seem to be happening in very slow motion as if the event took minutes rather than seconds.
    This all does seem very close to how things were sucked into a vortex in 1929 and for me my car crash analogy sums it up pretty well.

    I have since then been on skid pan courses and the key is to catch it before a certain point.

    I think that applies to the credit/liquidity affair and I believe we are past that point and heading inexorably for the wall its’s not yet a crunch but a skid ,the “crunch” is yet to come

  3. Mar 12   9:35 Posted by pegnu [report]

    Sudden Debt’s take:

    http://suddendebt.blogspot.com/2008/03/history-rhymes-in-slow-motion.html

  4. Mar 12   9:26 Posted by bsb [report]

    no - this is japan v2 - all institutions will be propped up, and market conditions will remain the same or worse for decades

  5. Mar 12   8:36 Posted by hedgehog [report]

    as Lex said ” another chance to sell into the bounce” - last out please remember the lights

  6. Mar 12   7:20 Posted by Anonymous [report]

    An institution needs to fail. From our gut, we all know there was too much excess, too much risk and too much complexity ingrained in the system. Failure (default risk) is being projected onto every entity increasingly (even US Treasuries have widened spreads) as the market prices in the expectation of serious default. Spreads will not return to “reasonable” or “fundamental based” levels until the failure - which we all know must come - actually happens.

    One of the big players needs to bite the bullet, the market will endure the pain, a new entity will be raised from its ashes and economic life will go on.

    Expect spreads to continue to increase - either through the form of credit spreads or inflation fears - and lending to continue to freeze in other markets (agencies???), until the failure occurs. Once it occurs, after a period of panic and much nail-biting as collateral is seized and sold, we will be free to lend again with confidence…

    But first, someone has to go.

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