“House to Street: Drop Dead” was how Marketwatch.com summed it up. On Monday the House of Representatives narrowly defeated TARP, the $700bn plan to stabilise the banking system by buying up distressed mortgage-backed securities and other assets. US investors’ nerves were already frayed by the failure of Washington Mutual last week; saddled with rotten mortgages, it became the biggest-ever American lender to fail as regulators seized control. The Dow dropped by 778 points (7%) on Monday – its largest points fall ever – but regained its footing as Congress stepped up efforts to pass the plan; it went back to Capitol Hill where the Sentate passed an amended version 74-25.
Interbank markets frozen
The delay sent credit markets “closer to breaking point”, as Economist.com put it. Despite major liquidity injections from central banks, the overnight dollar interbank rate jumped by 4% on Tuesday, before falling back, while three-month sterling, euro and dollar loan rates have continued to climb. “Banks just won’t lend, not even for five minutes,” one dealer told the FT. Moreover, noted Economist.com, some companies have struggled to roll over commercial paper (short-term debt to finance everyday activities such as paying staff). All this has raised fears of further bank failures, following a spate of rescues necessitated by funding problems. The frozen credit markets raise the spectre of a deeper and more prolonged global recession, as Alan Beattie said in the FT.
The passage of TARP may boost confidence in the credit and money markets by reducing uncertainty over the value of illiquid toxic assets. But with the government unlikely to pay high prices for them, it will do nothing to alleviate the shortage of capital in the banking system, which is the key problem. And with the US economy weakening and house prices still falling, more losses for banks are on the cards, implying a further squeeze on lending and growth.
US data getting worse
On the housing front, the Case-Shiller index covering 20 cities fell by a record 16.3% from a year earlier in July. Tighter credit is dampening demand, while the “huge overhang of unsold properties” and rising foreclosures hardly helps matters, said Anna Piretti of BNP Paribas. Tumbling house prices are set to encourage highly indebted and cash-strapped consumers to retrench further; real consumer spending is expected to show a drop in the third quarter, which would be the first in 17 years. The third quarter will see zero growth at best, reckons Ian Shepherdson of High Frequency Economics. As Alan Abelson said in Barron’s, “the great unwind… of debt addiction and insatiable greed” has a “long and painful way to go”.