Thursday, October 16, 2008

Who Trusts Governments? (fg)

I highly recommend amv's post. To him, and I agree, government bailouts won't cure the very root of the mess; it may just postpone the necessary re-thinking and adjustment in over-invested financial markets.

Politicans announced these days that they will provide free-lunch packages by hook or by croock. Let's see how financial market indiciators reacted. The following figure shows the TED, i.e. the difference between the three-month interbank lending rate and the three-month Treasury bill, indicating to the overall uncertainty and distrust in the interbanking market. Although the bail-out program is waiting in the pipeline (and believe me it will come!), market participants don't accept the rescue plan overwhelmigly; they dislike to smell the rat of catharses. In particualr, don't think that the tiny decline in the LIBOR rate last days looks like the process towards a normalization. This is just the reflex of overall falling interest rates which appears to be the result of the neccessary adjustment in the real and financial economy (see my former post on the urgency of a recession).

To sum up, the most impressive indicator, the TED spread, still remains at extraordinary high levels. Financial markets need to learn that the actually good idea of credit derivatives to transfer risk was feeded with cheap money, especially across the atlantic. It generated massive systemic risk in the financial system heated up by intransparency and wrong incentives. You may find a comprehensive analysis of the nature and consequences of credit risk transfer here.

UPDATE: I am not the only one who recognized that credit markets are not impressed by bailout plans. See Mish's Global Economic Trend Analysis.