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Black Friday?

Now we’ve got a particularly toxic mix of recession fear and possible reversal in interbank lending. This spells disaster. This post from Naked Capitalism sums it up pretty well:

Friday, October 24, 2008


I had warned readers against assuming that because we had a bounce in the equity markets, that life would soon return to normalcy (“It Isn’t Over Until the Fat Lady Sings”). But I didn’t expect a rout like this, particularly with no looming news trigger.

The yen has gone to 91. The Nikkei was down over 9%, most other Asian markets down 7%, Continental markets down over 10%, but have reverted to down a mere 7% plus. A more aggressive than expected production cut by OPEC has done nothing to stem the fall of oil, down 5%. Gold has fallen below (and a reader who sometimes laments the fact that he runs a gold fund noted that he had been watching trading this week hawkishly, and it had withstood attempts to drive it below that level). US stock futures trading has been restricted because it has fallen below 6%, its daily limit.

From the Wall Street Journal:

European shares tumbled Friday as fears of a long and deep recession grew, with the auto sector slumping after profit warnings from Renault and Peugeot-Citroen as well as weak results from Swedish truck maker Volvo.

The pan-European Dow Jones Stoxx 600 index dropped below 200 for the first time since mid 2003, falling 9.0% to 189.87. Among regional markets, the U.K. FTSE 100 Index dove 8.73% to 3730.78 and the German DAX 30 Index dropped 10% to 4068.43. The French CAC 40 index was down 10.2% at 2974.95, with Peugeot-Citroen among the biggest decliners, falling 14.1%.

And the credit market news is taking a gloomy turn again. From Bloomberg:

The cost of borrowing in dollars may rise as increasing prospects of a global recession prompts banks to hoard cash even after policy makers injected record amounts of the U.S. currency into financial markets.

The London interbank offered rate, or Libor, that banks charge for overnight loans in dollars may climb 4 basis points to 1.25 percent today, according to Jan Misch, a money-market trader at Landesbank Baden-Wuerttemberg, Germany’s biggest state-owned bank. It increased for the first time in 10 days yesterday. The three-month lending rate for Hong Kong dollars, known as Hibor, rose for the second day, gaining 5 basis points to 3.29 percent.

“The level of activity in the money markets remains significantly below standard norms and subject to sporadic abnormalities that can only be a function of illiquidity,” said Charles Diebel, head of European rates strategy at Nomura International Plc in London.

Now I want to know how Nouriel Roubini saw this coming. He went into what reader Dwight called Defcon One yesterday.

Marshall Auerbach e-mailed, saying (as we have) that the Fed is making matters worse:

All that’s left is the Fed buying longer-term Treasury securities to attempt to flatten the curve, get mortgage rates down, and add reserves. This will flood the market with reserves that now pay interest. so they can do this without a zero interest rate policy.

Their theory is that with more reserves bank will lend more, which is not the case, both in theory and in practice, as Japan proved not long ago.

Instead of the Fed buying longer term securities, the Treasury should simply stop issuing them and issue more bills. The Treasury not issuing longer term securities is functionally the same as the Treasury issuing them and then the Fed buying them, but with a lot fewer transactional costs.

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