Do everything

Martin Wolf is spooked. In today's column in the Financial Times (It is time for comprehensive rescues of financial systems), he states:

The fear driving today’s breakdown in financial markets is as exaggerated as the greed that drove the opposite behaviour a little while ago. But unjustified panic also causes devastation. It must be halted, not next week, but right now.

The situation, he believes calls for an all-of-the-above approach to the mess: do “everything.” That means government guarantees and unsecured central bank lending to unlock the credit markets, recapilization of the banks with a direct infusion of funds and pulling the bad assets off the books through a TARP mechanism.

At this point, I agree that the do everything approach may be needed. But even there, Wolf is only part way to the “everything” that needs to be done.

There are three interrelated problems. First is the financial system meltdown: the credit lockup and the huge uncertainty of the fiscal status of banks -- leading to a shareholder run on financial stocks. The second is the stock market meltdown as that shareholder run drags everything else down. The third is the underlying weakness in the economy. This weakness both helped precipitate the financial meltdown (as the housing bubble burst as mortgage payments were missed and foreclosures rose) and has been, in turn, fueled by the financial crisis. As the Wall Street Journal reports:

The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.

But housing is just one bit of the problem. Weakness is showing up through out the economy as companies and individuals pull back.

Most of the actions by the various governments worldwide are aimed at addressing the first two problems: the financial markets problem directly and the stock market problem indirectly by addressing the financial market problem. At some point, the third issue of the weak economy must be addressed. And addressed in a way that goes beyond just the housing portion of the problem.

Right now, the various governments need to stop the panic. As Vikas Bajaj writes in the New York Times, Forget Logic; Fear Appears to Have Edge:

The technical term for it is “negative feedback loop.” The rest of us just call it a panic.
How else to explain yet another plunge in the stock market Tuesday that sent the Standard & Poor’s 500-stock index to its lowest level in five years — particularly in the absence of another nasty surprise?

Crafting the larger economic package will be the task of the new Administration and the new Congress. What that package includes will likely be the subject of intense discussions between the incoming Administration and the leadership of the new Congress -- starting November 5.

So stay tuned.