Unstable Assets, Tight Credit Add to Global Economic Woes

MBA (10/9/2008 ) Sorohan, Mike; Murray, Michael
Despite a 50 basis point cut in the federal funds rate, as well as actions taken by nearly two dozen other central banks, global economies continued to suffer from widespread turbulence.
The U.S. stock market, rallying briefly following the Federal Open Market Committee announcement, continued their rollercoaster ride yesterday, finishing nearly 200 points lower than Tuesday. The Dow Jones Industrial Average has lost substantial value—exactly one year ago, the Dow Jones reached its highest level ever, topping 14,000; yesterday, the Dow Jones finished at 9,258.

Treasury Secretary Henry Paulson Jr. said yesterday that U.S. and global financial markets continue to be “severely strained.”

“A chain of events caused by the ongoing housing correction has reverberated through U.S. banks and financial institutions and has seriously impacted the underlying economy, reaching American households and businesses,” Paulson said. “A root cause of this situation is the housing correction and a lack of confidence in mortgage assets, as well as a lack of confidence in many of the financial institutions that hold these assets. Because of this widespread uncertainty, investors are hesitant to commit capital to financial institutions. Investor confidence is critical to restore liquidity and enhance the stability of our financial system.”

Part of the problem, said Scott Baret, partner of regulatory and capital markets at Deloitte & Touche LLP, New York, is the lock-up of the financial credit markets. Inability to stablize on balance-sheet values, inability to sell those assets and borrower difficulty finding financing contribute to instability, despite the efforts of the federal government.

"The reality is that all operating models, not only financial institutions but also commercial entities that have been instructed to operate in an environment where credit is normally available, right now—in the short-term, medium-term and long-term markets--it is not available," Baret said. "The fundamental reason credit is not available is that there is a mistrust between banks because of a lack of asset stabilization."

“The risk is going to be—is there enough capital there to support the cost of funds going forward from these sources of money,” said Mark Peterson, managing director at Black Rock, New York.

Baret said residential market ramifications on securitized products present a key for solving the economic crisis and until residential real estate stabilizes, the crisis will continue.

"The toga party that existed pre-2007 has ended—has gotten to where we are now—and the hangover is something that is over the economy right now, and the economic consequences are slowly rippling through,” Baret said.

While residential mortgage delinquencies and foreclosures impact the economy, Baret said they also provide a litmus test on asset stabilization because unstable assets exist in residential and institutional markets.

"We are where we are right now,” Baret said. “The question is—what comes next.”

Paulson said the federal government would continue to take action at stabilizing the markets. “This financial market turmoil is now directly affecting more families and businesses. When banks can not finance at reasonable levels, and can not or are not willing to lend, everyone in our economy who depends on credit suffers. The capital markets are the pipes through which money flows to finance student loans, car loans, home loans and small businesses' payroll and inventory. And uncertainty and a lack of confidence have clogged our basic financial plumbing. While our actions have been aimed at restoring financial markets and institutions, our purpose is to prevent financial market difficulties from further impacting businesses and families across the country.”