Tags: financial | meltdown

Global Rate Cuts Won't Even Come Close

By Hans Parisis
Wednesday, 08 Oct 2008 03:22 PM Current | Bio | Archive

It's a fact that we are very close to a systemic financial meltdown if things don't change for the better, and do so very rapidly.

I consider today's "cosmetic" 0.50 percent rate cuts by the Fed, the European Central Bank, the Bank of England, and other central banks too little, too late. The Fed's 50-basis point cut is too small given the huge destruction that the recent and un-abating financial shockwaves have caused to confidence in the financial system, to the real economy, and to wealth in general.

Before the Fed ends cutting, in the near future, the rate will be closer to zero than to 1 percent. The half of a percent cut by the European Central Bank is also much too small. They will need to cut at least 150 basis points before there is hope of restarting their economies and unfreezing their financial markets. (They have room to do that because the ECB now stands at 3.75 percent after the today's rate cut.)

All that said, I think that these rate cuts will only have limited effects as they don't resolve the fundamental problem in markets, that is, the big rate spreads relative to "safe rates" because of the enormous, unidentifiable counterparty risks of insolvent entities.

Unfortunately, it will take time (and time is not our friend at this moment!) before markets will be able to sort out the solvent banks from the insolvent banks and entities. Besides this, while all these uncertainties will still dominate the markets, it will be absolutely necessary to make huge liquidity injections in the non-banking and corporate sectors.

In that context, the historic decision the Fed took yesterday to support the commercial paper market is surely a step in the right direction.

As things stand today, there is no doubt in my mind that the $700 billion rescue bill (known as Troubled Asset Relief Program, or TARP) won't do the trick in its current form and therefore should be radically adjusted and expanded.

If we want to avoid a long and deep recession, it will be absolutely necessary to:

  • Allow the government to inject public capital in banks thereby helping them to recapitalize rapidly and comply with their Tier 1 capital requirements.

  • No doubt that the banking sector also will have to close all insolvent institutions in a very short time frame.

  • In order to avoid a massive hurricane of foreclosures, it will be necessary to reduce the face value of mortgages held by distressed homeowners.

  • Finally, in order to maintain confidence in the remaining solvent financial institutions and avoid unjustified but possible bank-runs, depositors will need a governmental assurance of a generalized but temporary (to avoid moral hazard and costs) blanket guarantee of all deposits, as for instance has been done in Ireland.

    In my opinion, investors shouldn't even try to look for silver linings at the moment, when financial and economic conditions are at extremely high danger levels.

    The world needs quick and drastic rescue actions. If that's not the case, at home as well as worldwide, we could risk a very nasty, deep, and long recession that could, who knows, deepen into a depression.

    Because of all this, for now and as I've said before, cash and cash equivalents remain king as never before.

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    HansParisis
    It's a fact that we are very close to a systemic financial meltdown if things don't change for the better, and do so very rapidly. I consider today's "cosmetic" 0.50 percent rate cuts by the Fed, the European Central Bank, the Bank of England, and other central banks too...
    financial,meltdown
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    2008-22-08
     

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