(Which is, of course, a song from the great Buffy episode, “Once More, with Feeling.”)
After the last week, it was a relief to have a relatively slow news day, at least compared to the preceding days, to catch our breath and take stock of things (and get over my cold). American and European policy makers decided they needed to use overwhelming force to stop the panic in its tracks. It will take some time to see if they used enough; the credit markets have certainly not opened up, although some indicators have gotten marginally better (the TED spread is slightly down; T-bill yields are slightly up).
There are two directions things could go. First, it is possible that the credit markets will not come unstuck, and even more force will be required; blanket loan guarantees (for all bank obligations) and large recapitalizations (more than 3% of assets) would then be called for. Second, and more likely, we think, credit will gradually start flowing again. But even in that case, the global economy will be far from out of the woods. Here are the top issues that will still need to be faced:
- Implementing the Paulson plan, including both bank recapitalization and, if still included, asset purchases. This will require dealing with all of the issues of governance and pricing that we have commented on previously.
- Containing the damage of falling housing prices and foreclosures. Asset prices do need to fall to reasonable levels – trying to prop them up at artificially high levels will only hurt the economy in the long run – but limiting an overcorrection and limiting the collateral damage have to be priorities.
- Stimulating the real economy. Even if the credit crunch eases in, say, the next few weeks, the last month has already done significant damage to the global economy (which was already in the midst of a slowdown). For starters, just think of all the uncertainty and anxiety that have been generated in the last month, and the impact that will have on spending and investment by consumers and businesses. The fall in the stock market will also add to the negative wealth effect of falling housing prices.
- The international dimension and emerging markets. We could be moving to a situation where core banks in wealthy countries are considered safe, while banks in emerging markets are still considered shaky. This could trigger a repeat, on a larger scale, of the emerging markets crisis of 1997-98. And severe economic dislocation can always have political consequences as well.
- Update: How did I forget … financial sector regulation?
These are some of the major issues we will be thinking about over hte next few weeks and months (and possibly years). Let us know what else you think should be on the agenda.