It continues to be all about credit

October 6, 8:25 PMProgressive Politics ExaminerJay McDonough

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Anyone else get a knot in their stomach watching the stock market today? The Dow was down 800 points during the day, eventually closing down nearly 370 points.  Anyone hoping the market would respond favorably to the TARP (Troubled Asset Relief Program, i.e., bailout) is now seriously shell shocked. 

As noted previously, the issue is not how well the Dow does or doesn't do, it's all about credit availability.  Credit is not available still and the bailout, in and of itself, does not guarantee credit will become available.  As noted in the previous post, the banks could choose to refuse the bailout funds to protect the exec's compensation, they could choose to hold the mortgage securites because they're unhappy with the price the Treasury is willing to pay, or they could take the bailout money and just hold it as liquidity.  No guarantees at all the banks will start lending again.

Barron's suggests a couple ways to stimulate the credit availability:

1.  The quickest and easiest first step would be an internationally coordinated cut in interest rates carried out by the Big Three central banks -- the Federal Reserve, the European Central Bank, the Bank of Japan -- with the Bank of England, the Swiss National Bank, the Bank of Canada and the Reserve Bank of Australia all joining in.

 2.  Changing the mark to market accounting rules.  Mark-to-market accounting, which stipulates that assets be carried on balance sheets at their current market price, has been blamed for exacerbating the credit crisis. By requiring writedowns on loans and securities that have declined in price, institutions have to make a corresponding reduction on the other side of the balance sheet, to capital. That only worsens the credit crunch.

"This cycle can be broken if banks communicated an accurate or conservative assessment of the fair value of their assets in the footnotes of their financial statements, thereby telling equity and bond investors what they need to know to value the company. But if these losses were accrued over the remaining life of the assets, thereby avoiding the immediate hit to the book value of capital, the selling pressure would be reduced, which might even allow prices to rise and reverse the cycle and improve sentiment. This seems pretty obvious without any knowledge of history, but history overwhelmingly confirms the need for such a change."

 3.  Capital needs to be bolstered.  The government can inject capital into institutions, as the Treasury did with Fannie Mae and Freddie Mac through the purchase of preferred stock. Or, as the Fed did with its loan to American International Group, which will give the central bank warrants to buy 79.9% of the insurer. Kasriel notes that warrants or additional preferred reduces the value of outstanding shares.

Nouriel Roubini, the New York University economist whose Cassandra-like warnings about the impact of the credit crisis should have been heeded, says radical steps will be needed, including government capitalization of the banking system.

I wonder what tomorrow will bring.