JEFFREY BROWN: Until mid-afternoon, it looked like a relatively calmer day on the stock market. And then yet another dramatic drop took the Dow down sharply.
And there was talk of yet another major government move, with the Treasury Department considering a direct investment in banks.
We look at the latest developments now with William Poole, former president of the Federal Reserve Bank in St. Louis. He’s now a senior fellow at the CATO Institute; Hugh Johnson, chairman and chief investment officer at Johnson Illington Advisors; and Krishna Guha, the U.S. economics editor for the Financial Times.
Well, Hugh Johnson, can you tell exactly what happened this afternoon to bring on the drop? It dropped from about 3 o’clock to 4 o’clock today about 400 points. What happened?
HUGH JOHNSON, Johnson Illington Advisors: Well, we had bad news on General Motors, but I think really what it is, is that you have a lot of sort of institutional investors, as well as individuals, that are sort of prepared to sell or they have it in their mind that they’re going to sell.
They’re kind of hopeful that the stock market is going to rally and they can postpone their selling, but when the stock market doesn’t rally, as it didn’t do by 2 o’clock, they kind of throw the towel in, if you may, and start to do their selling.
There’s some institutions, such as mutual funds, where they’re faced with redemptions from their shareholders. That is, their shareholders want their money back, and they have no choice. And by the end of the day, they have to sell.
So come 2 o’clock, they start to sell. And that’s why it picks up in the latter part of the day; the sellers have to get out.
JEFFREY BROWN: Krishna Guha, what would you add to that? Who is selling? And why so fast?
KRISHNA GUHA, Financial Times: Well, as your previous guest said, one of the factors causing this is redemptions out of stock market investment funds.
But I think there’s a wider point here, which is any given amount of selling now is producing dramatic falls in the stock market. And there’s a simple reason for that: There’s just very little buying interest out there. There’s very little interest from end investors.
But also the securities firms that normally act as so-called market makers — that’s to say they offer to buy and to sell prices with a spread — stocks with a spread between those two prices — those banks aren’t doing the job that they used to do.
They don’t want to put their capital at risk to the same extent, and they’re scared by the extraordinary volatility that bounces up and down in stock prices.
New Treasury involvement in banks
JEFFREY BROWN: Mr. Poole, the day started with reports about the Treasury -- this idea of the Treasury making direct investments in banks. How would that work? I realize it's not finalized yet, but why would they be taking that action? And how might it work?
WILLIAM POOLE, Former President, Federal Reserve Bank of St. Louis: Well, the fundamental problem we face in the banking system is that people don't know whether their banks are truly solvent or not because of all the uncertainty over what their assets are worth. And that means banks are uncertain about each other, as well.
What we need is for the banks to become unquestionably solid. Nobody has any concern about lending money to Berkshire Hathaway or Microsoft. Those companies are very, very well-capitalized. And we need to put our commercial banks in the same boat, the same situation.
JEFFREY BROWN: But to stay with you, this kind of direct involvement by the government in the private sector banking system is quite a philosophical turn, isn't it, in our market system?
WILLIAM POOLE: Yes, it is, but I think it's necessary. I think the idea would be, certainly from my perspective, from a libertarian perspective, we want to keep the fundamentals of the economy in place. And if the government can put capital in for a period of time and withdraw it later when the economy has become prosperous again, then we will have gotten out of this pretty cheaply.
JEFFREY BROWN: Krishna, you've been talking to people at the Treasury today. Any word on how it might work? Would it be voluntary, for example, for banks?
KRISHNA GUHA: The assumption at this point is that it would be a voluntary plan. So it wouldn't be identical to the plan, for instance, announced in Great Britain this week, where they essentially are requiring the biggest banks to either raise more capital from the markets or go to the government and get government capital.
JEFFREY BROWN: And why would we do it a different way? Why would we make it voluntary?
KRISHNA GUHA: Well, I think there are a couple reasons here. The first is that the U.S. authorities don't want to take the extreme measure of the government instructing privately owned companies, financial banks here, what they have to do, particularly the healthier ones. Ordering them what to do seems a stretch even at this juncture.
The second point is that the U.S. financial system involves many more important firms, a much larger number of different banks and other financial firms, some of which aren't even regulated as banks.
So this is a more complicated system. It may need more case-by-case treatment. And the government prefers a voluntary approach here.
Levels of nationalization
JEFFREY BROWN: Now, Hugh Johnson, this plan was out there this morning when the markets opened. What do you make of the plan? Or what do you hear about it, in the terms of its ability to turn things around?
HUGH JOHNSON: Well, it creates a little bit of concern. You know, the private sector, obviously, is never very -- never really likes the public sector getting involved in the private sector or even if it's just injection of capital, but taking a position, that's something just short of nationalizing the commercial banking industry.
So I think that investors generally feel very, very uncomfortable with this move.
At the same time, as has been sort of stated, if it's a plan to somewhat nationalize, partially nationalize the banks, buy stock in the major commercial banking companies, and then eventually to denationalize or to sell that interest, I think that would go down fine, particularly if it adds enough capital to start the lending process again.
Remember, what this is all about is there's deep concern that the lending process is not really working or that companies are not able to borrow money in order to do things like meet their payrolls, pay their bills, and finance their inventory.
So if that helps to do that, that will start to build or rebuild confidence, confidence in the economy, confidence in our credit mechanism. And if that happens, the stock market will stabilize.
And so if it gets that result, it will be just fine, it will do what it is, but we've got to denationalize if we do nationalize to some extent.
JEFFREY BROWN: Mr. Poole, we've been talking all week about various dramatic moves and then the possible counterintuitive results. I wonder, in this kind of a plan, is there a potential problem that banks that might choose to participate would be showing themselves to be unstable and therefore get in worse trouble?
WILLIAM POOLE: Well, given that the plan in the United States presumably would be voluntary -- and I must say, the word "nationalization" is a bit scary and maybe scarier than it should be, because, if it's voluntary, it's not as if the government is seizing the banks in any way. It's putting money in, making a voluntary investment.
And I think the issue there is that a bank that gets into this, that wants the government money, ought to do other things, such as raising private money at the same time, so that it comes out with the capital infusion leaving it with unquestioned and unquestionable strength.
That strategy should leave the bank better off and dispel potential concerns that a bank is seeking government aid out of weakness.
Extreme steps, little reaction
JEFFREY BROWN: Now, Krishna, we just heard a report that President Bush is going to speak tomorrow morning, I think, before the markets open. Every day there's a different action by the government that so far hasn't had the intended results.
Is there starting to be a fear of -- I mean, is there a potential of the government running out of ammunition, in a sense?
KRISHNA GUHA: Well, there is a real concern among policymakers that they've taken some very big steps in recent days. I mean, let's not forget, it was only on Wednesday that we got an international interest rate cut. It was only a day or so before that that the Federal Reserve said it would buy short-term IOUs from companies. So...
JEFFREY BROWN: And less than a week since the federal government with the big Treasury bailout package.
KRISHNA GUHA: Absolutely. So extreme steps taken, very little response from the markets, and immediate craving for the next big fix, the next government intervention. That does worry people.
Now, it's my understanding at this juncture that President Bush is not intending to make a major announcement in his address tomorrow morning. But of course the situation is fast evolving, so no one can be 100 percent certain.
What the president is likely to do, rather, is to try to explain to the American people that the government is on the case, that it is pursuing a number of strategies that will together contain this credit crisis, and make sure we don't have a disastrous economic outcome.
JEFFREY BROWN: Hugh Johnson, what is your sense of the government's ability to step in and shape the markets and, I guess at some point, hope that we reach a bottom?
HUGH JOHNSON: Well, history tells us that they have to perform what they're doing now, which is adding money or liquidity to the system. And if it doesn't work, if the credit mechanism doesn't start to work again, if confidence isn't restored, then they simply have to do it again, and again, and again until confidence is restored.
So, quite frankly, they have no choice but to continue on this course that they're on. They've been very creative. They've been very aggressive. And I'm hopeful that at some point we'll see the markets stabilize and confidence return.
There are actually, despite all of this sort of dark cloud, some silver linings here, because it's rare that you see this level of pessimism coupled with what might arguably be a cheap level for equities, as well as some, you know, race-for-the-exits-type panic selling.
When you see that, that's more characteristic or symptomatic of the later stages of a decline in stock prices, not the early or the mid-stages.
JEFFREY BROWN: And, Mr. Poole, a brief last word from you. You've been at the Fed. Where are you now? What are you thinking?
WILLIAM POOLE: Well, I want to emphasize a point that we must not lose sight of. With all of this turmoil, the underlying productivity of the economy has not been affected. The skills of our labor force, our capital stock is all there, our factory buildings, our transportation system. All that is intact.
And when we can get the financial system straightened out, the mess cleared up, then the inherent productivity of the U.S. economy will show itself again and growth will resume.
A lot of gloom out there, but there are market processes at work, as well as the government steps, that are going to get us out of this. I don't know when, but it will happen.
JEFFREY BROWN: All right. Happy to end on an upbeat note tonight. William Poole, and Hugh Johnson, and Krishna Guha, thank you.