TOPICS > Economy

Bailout Fails to Stem Credit Fears in Financial Markets

October 6, 2008 at 6:10 PM EDT
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Despite the approval of a sweeping $700 billion bailout bill on Capitol Hill, the downward march of the financial sector continued Monday as major world and U.S. markets plummeted.
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JEFFREY BROWN: It was a day when the global nature of the financial crisis hit home: deep drops in foreign markets, followed by more on Wall Street, where the Dow has now lost more than 10 percent of its value in the past week, the S&P 500 more than 15 percent.

We look at what’s happening now with Scheherazade Rehman, director of the European Union Research Center and professor of international finance and international affairs at George Washington University; James Angel, an associate professor of finance at the McDonough School of Business at Georgetown University; and Ed Yardeni, president of Yardeni Research, an independent investment research firm.

Well, Ed Yardeni, it was just Friday that the financial rescue plan was passed. What accounts for today’s drop on Wall Street?

ED YARDENI, Yardeni Research: I think in some ways it’s a bit of a disappointment with the plan, a confusion about how it’s going to work. It’s an impatience.

But, you know, I think at the end of the day it was just panic selling by institutional investors, particularly hedge funds, that have been facing redemption requests from their investors.

Some of them may just want to get out of the business, because, you know, once you fall below the so-called high-water mark of your fund, if you don’t get back to it, you don’t earn those kind of big fees. So that may be part of it. And I think the public is genuinely scared.

JEFFREY BROWN: Oh, so you see — I was going to ask you about small investors and depositors. You see it starting to hit them, as well? I should say us, as well?

ED YARDENI: Well, yes. In a perverse way, the way the rescue package was sold was with a great deal of fear. It was sold with the idea that, if we don’t pass the Troubled Assets Relief Program, then it could lead to economic catastrophe. And I think a lot of people weren’t aware that we were that close to catastrophe.

JEFFREY BROWN: Professor Angel, you were just nodding your head as he was talking. What do you see happening here today?

JAMES ANGEL, Georgetown University: Well, we live in a global market. We live in a global economy. And today we saw not only impatience with the rescue package, but we also saw reaction to what’s going on in Europe.

As was pointed out in the introduction, there’s a lot of economic problems over there, as well. And when the European markets go down, the U.S. markets often go down in sympathy.

JEFFREY BROWN: We’re using the term “volatility.” And Ed Yardeni used the word “panic,” I think. Panic? Is there an order to what we saw today? At one point, the Dow dropped 800 points and then it came back to close around 370 or so. How do you describe it?

JAMES ANGEL: Well, this is a classic financial panic. And I actually am teaching a course in financial panics at Georgetown University.

And this is like the kind we are reading about in the history books, in which you have some economic bad news, and people don’t really know what’s going on, who’s solvent, who isn’t. So what we see happening is people running for the fire exits at the first hint of trouble.

But on the other hand, people know that, when the turnaround comes, it often comes very quickly. As a matter of fact, the best year in U.S. stock market history was 1933 during the depths of the Great Depression. In that year, the U.S. stock market went up 67 percent.

So as — so you often have very high volatility at times like this, where some people think, “OK, the worst is over. Time to get in.” Oops, too early, time to get out again. So that’s what we see.

Europe searches for answers

Ed Yardeni
Yardeni Research
I think what happened this weekend is there's a realization that this really is a global problem, that it's not contained, that it really continues to spread.

JEFFREY BROWN: Now, Scheherazade Rehman, bring Europe into this for us, because, as we said, that's where things started today.

SCHEHERAZADE REHMAN, George Washington University: That's right.

JEFFREY BROWN: What's the problem there? Is it our problem spreading or is it something special there?

SCHEHERAZADE REHMAN: Oh, clearly it's our problem spreading. I think the Europeans took leave of their senses and they thought that this was a U.S. problem and they would hardly be touched by it. They are screaming now that the sky is falling and, in some respects, it is.

Europe's economy is more heavily bank-dependent. And when -- as this is hitting, they realize that getting out of this mess will be much harder for them than it is for us. For example, they cannot do an E.U.-style federal bailout.

JEFFREY BROWN: Of the kind we did.

SCHEHERAZADE REHMAN: It's not possible. Absolutely right. It's not possible. They're 27 countries. And banking is relatively still deregulated -- not regulated as well, in terms of standards across the board.

And so you've got a beggar thy neighbor policy going on in Europe right now, each country for itself, in terms of bailing themselves out.

JEFFREY BROWN: A lot of -- we saw a lot of activity over the weekend, right?

SCHEHERAZADE REHMAN: Absolutely.

JEFFREY BROWN: Leaders gathering, various bailouts, but you're saying none of that was very well coordinated?

SCHEHERAZADE REHMAN: President Sarkozy, he wanted this bailout very badly. He holds the European presidency, but the U.K. and Great Britain -- the U.K. and Germany were not willing to play ball this time, because they're worried about their own financial markets. When Germany safeguards all the savers in Germany, that's a lot.

JEFFREY BROWN: And so -- but why are they unable to reach some agreement as a group?

SCHEHERAZADE REHMAN: Well, on the legal sense, there is no huge federal budget to borrow money from. And on a smaller scale, Spanish taxpayers don't want to bail out Greek banks, and they will not find the political support for that.

JEFFREY BROWN: And, Ed Yardeni, would a failure in Europe to come to some kind of overarching plan, would that then blow back in a sense and hurt our efforts here, as well?

ED YARDENI: I think that's the risk. And I think that's what investors are concerned about, that for quite some time, for over a year, it appeared as though the credit crisis was mostly a United States phenomenon.

I think the disappointment was that there was lots of talk that it would be contained, instead of continue to spread. It spread from subprime to other areas of our capital markets. And now it's obviously also having a negative impact on our economy.

I think what happened this weekend is there's a realization that this really is a global problem, that it's not contained, that it really continues to spread.

And if Europe goes into a deeper slowdown or recession, that's going to depress our exports. And, unfortunately, exports has been one of the few bright spots for the U.S. economy.

JEFFREY BROWN: How do you see this, Jim Angel? How much are we dependant now on what happens there as much as they are on us?

JAMES ANGEL: We're all in this together, that we had a global housing bubble, and although a lot of the problems first surfaced in the U.S., with all of the subprime loans we made and marketed around the world, many other countries also had problems in their banking sector with locally developed loans.

Now, we export to them. We import from them. They import from us. We're all in this together.

Learning from the American crisis

Scheherazade Rehman
George Washington University
The Europeans are doing what we did two weeks ago, trying to get together and find a solution. And they cannot do a big bailout. And so I think they're in much rougher waters than we are looking down the road.

JEFFREY BROWN: Scheherazade Rehman, President Bush we heard today cautioned that this is going to take a while. Now, why does that not sink in to markets here and in Europe? Or might it at some point?

SCHEHERAZADE REHMAN: I think the Europeans are just beginning to realize that this is their problem and that this is going to grow on their soil. I think I'd much rather be the American economy, because we can manage this.

The Treasury secretary is now in the process of hiring some very, very sharp professionals to manage now the bailout process as to what assets to buy, how to manage them, and where to go from here.

The Europeans are doing what we did two weeks ago, trying to get together and find a solution. And they cannot do a big bailout. And so I think they're in much rougher waters than we are looking down the road.

JEFFREY BROWN: What about a country like Germany, the biggest power in Europe? How much can it do on its own? And how much does it then engender, oh, I don't know, anger from other countries in Europe?

SCHEHERAZADE REHMAN: I think the Irish started it off by saying that we're going to safeguard ourselves first and then we, of course, support any E.U.-wide plan, but our markets come first. And quickly five or six countries followed, but Germany being the more recent one.

And I think that the Germans have to do it. They have the largest financial markets, like the French do. Smaller countries to some extent are left on their own, in terms of not having a wider bailout scheme.

JEFFREY BROWN: We heard a reference to Iceland in that ITN piece.

SCHEHERAZADE REHMAN: Iceland has got hit very, very hard. I mean, their currency dropped 30 percent in one day, which is a lot.

They had a phenomenal rate of return because they've had such high interest rates for so many years, so they did very well, and now they've got very hit. This is an old-fashioned banking panic.

People are scared. There's the run on the banks. This has happened here. It's definitely happening in Europe.

As I mentioned earlier, Europe is very heavily banked. The economy relies more on banks and loans than anything else, not like in this country, where financial companies are more diverse in their sources of financing.

Awaiting results of bailout

James Angel
Georgetown University
... when (banks) go out and they push down interest rates, they push money into the markets. And that means the banks have more money to lend.

JEFFREY BROWN: And, Ed Yardeni, you come back to this psychology question. It's a day when we went below 10,000 for the first time in quite a while. Is that significant? Or do we overplay benchmark round numbers like that?

ED YARDENI: No, it's significant. It makes headlines. And headlines get everybody's attention. And I think the fact that we just cut through 10,000 like it didn't mean much of anything is actually unsettling, because we had spent so much time at 10,000 a few years ago. And all of a sudden, we had a nice rally since 2003, and now we've given it all back, so that's very unsettling.

May I make one point on this rescue plan?

JEFFREY BROWN: Yes.

ED YARDENI: The jury is still out on exactly how it's going to get implemented and whether we're really spending the money wisely. There's other ways to spend the $700 billion than buying distressed assets in sort of a generic fashion.

I think that we might get more bang for our buck if we actually just bought all the distressed subprime mortgages and Alt-A mortgages, kind of the second-worst mortgages in this pile of toxic assets.

We really need to take the toxin out of these capital markets rather than taking assets that have been mixed all together. We need to pay them off and send the cash to those who have these securitized pool of fixed-income assets.

So I think there's actually still quite a bit of concern about whether this rescue plan is going to work as intended.

JEFFREY BROWN: Well, Jim Angel, in addition to that question of looking forward, how's that plan going to work, there was talk today about some kind of coordinated move between the Federal Reserve here and European central banks. What would that entail? What is possible to be done at this point?

JAMES ANGEL: Well, both banks in the U.S. and in Europe, the central banks, can lower interest rates. What that means is they would go into the market and they would buy up securities, usually government securities, but in these times of crisis they might want to buy up private securities, like commercial paper.

And in doing so, they pay for it with the money they create. So when they go out and they push down interest rates, they push money into the markets. And that means the banks have more money to lend.

JEFFREY BROWN: And a brief response from you. Do you see that as possible from Europe, Europe working with the U.S.?

SCHEHERAZADE REHMAN: I think they definitely are going to reduce interest rates. They have to now at this point. The European Central Bank has no choice.

But there are lots of other options here, while we're trying to work out the bailout plan in the U.S. and the Europeans are trying to get their act together, at least individually, and that is, for example, extending lines of credit from the Federal Reserve to banks lending to other banks, you know, and this is a special list of banks which we deem safe.

Perhaps extending the time frame for unemployment benefits, I mean, these are all things that could shore up the market in the short run.

JEFFREY BROWN: All on the table at this point?

SCHEHERAZADE REHMAN: That's right.

JEFFREY BROWN: All right, I want to thank you, all three. Ed Yardeni in New York, Scheherazade Rehman, and Jim Angel here with me in Washington. Thank you all very much.