At each previous crisis point markets have rallied on news of a government bailout.
Not so today. America’s main indices have crashed through key fundamental support levels. As at 19:00 BST:
S&P 500 -4%
DJIA -3%
Nasdaq -4%
Leading the collapse, the crumbling Goldman Sachs and Morgan Stanley share prices. At one point GS was down 26% at around $100 a share. Morgan Stanley down an incredible 44%.
Nevermind the fact that both have reported - relatively speaking - strong results this week.
The fact remains: liquidity in the US has collapsed in the past few days. The crisis in the short term debt markets is far far worse than it was in August last year, or indeed in March, when Bear was bailed out.
Dollar Libor is sky high. US banks aren’t lending to each other, and with such dramatic declines in Goldman and MS share prices, what little confidence there is is fast evaporating. Felix Salmon rightly notes:
Morgan Stanley’s credit default swaps are now trading at 925 basis points, which is a very distressed level.
Does this mean that Morgan Stanley is now in the crosshairs? It would certainly appear so, yes. That alone could explain the stock-market drop: there was a brief rally yesterday afternoon on the AIG bailout, but Morgan Stanley’s balance sheet is just as big as AIG’s.
My feeling is that it’s high time Morgan Stanley found a buyer. Or things could get very ugly again very quickly.
As a further point: MS CDS protection sellers are now requiring 14 per cent up front.
Events neatly summarised by the FT’s John Authers:
Lewis Carroll’s White Queen “believed as many as six impossible things before breakfast”. Traders could use that skill. Here are six things we have been asked to believe since markets closed on Tuesday.
First, the US Federal Reserve is lending $85bn to American International Group to stop it from going bust. AIG is an insurer, not covered by the Fed. The action is without precedent. Does it damage the decisive move against moral hazard when Lehman was allowed to fail? Arguably not. AIG was of greater systemic importance. And Wednesday’s market response suggests that it in no way dampened aversion to risk.
Second, a US money market fund has “broken the buck”, or dropped below a nominal value of $1. For decades US savers had thought this impossible.
Third, the yield on the world’s safest investment, three-month Treasury bills, dropped to 0.15 per cent, its lowest since Pearl Harbor. Safety has not been so expensive since the war.
Fourth, the US Treasury had to bolster the balance sheet of the Federal Reserve, the anchor of the world financial system.
Fifth, Wall Street’s last two independent investment banks, Morgan Stanley and Goldman Sachs, will stay independent for days at most, judging by the price of their equity and credit.
And sixth, the risk that the US itself defaults, according to credit markets, has quadrupled in the past six months. Its triple-A rating, according to one rating agency, is “not God-given”.
All six things appear to be true. A seventh, pushed by contrarians, is that it is time to buy. The last rally, in July, started when restrictions on short-sellers were announced; draconian measures against shorts were unveiled on Wednesday. And extreme panics generally precede rallies. But this panic must be resolved first, and it looks different from the panics that have preceded it this year.
