The Markets Are Terrified: Should You Be?

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Posted Sep 29, 2008 07:38pm EDT by Aaron Task in Investing, Recession, Banking
Related: ^DJI, ^GSPC, ^IXIC, SPY, DIA
The "sum of all fears" scenario became reality Monday after the House rejected a $700 billion bailout package.

The Dow suffered its largest point decline in its history, 778 points, while the S&P was off 8.75%, its worst decline since 1987, and the Nasdaq lost over 9%, which will certainly grab headlines -- and rightfully so.

But the real crisis remains in the credit markets, as Bloomberg details:

Rates on three-month Treasury bills declined 55 basis points to 0.29%, not far above the levels hit on Sept. 17 when they hit their lowest level since WW II.
The three-month London interbank offered rate (LIBOR) -- a key measure of lending rates between banks -- climbed to 3.88%, the highest level since Jan. 18 and up from 2.81% a month ago.
The so-called TED Spread -- the difference between what banks and the Treasury pay to borrow for three months, widened to 3.59%, the most since Bloomberg began compiling data in 1984. The TED Spread was 1.10% a month ago and has averaged 0.56% over the past five years.
In plain English, those figures mean banks are extremely reluctant to lend to each other, which means they're not going to lend to you and I as consumers, or businesses either. The Fed is injecting tremendous amounts of liquidity into the financial system to get banks lending again, to little avail so far.

This isn't just a long-term concern: corporate America relies on overnight lending and short-term commercial paper markets to fund day-to-day operations; an inability to tap those sources of liquidity could result in mass layoffs in the "real" economy, which is something to fear.

Treasury Secretary Hank Paulson warned about such dire consequence before, during and after the House vote on the bailout package Monday.

"Markets around the world are under stress and that reduces the availability of credit that businesses across America depend on to meet payroll and to purchase inventories," Paulson said Monday afternoon. "We've got much work to do and this [rescue package] is much too important to simply let fail."

On Monday, investors got a taste of just how important the absence of a plan can be. I wouldn't recommend anyone sell after a day like Monday but wouldn't be in a rush to buy stocks either. Monday's point decline was the worst in the Dow's history but it didn't make the top 10 on a percentage basis. Notably, three of the Dow's five worst percent drops occurred within a 6-week period in 1929 and two of the top 10 occurred in October 1987, meaning things can get worse and really big declines tend to occur in clusters.

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