The Calm Before the Storm?

It’s definitely not just stocks: the credit markets have failed to deteriorate today as everybody expected them to, on the day after the largest banking collapse in US history. Libor’s down a little, TED’s down a lot, and generally there’s no sign at all of any panic.

Justin Fox has a few theories for why this might be the case. The first one is the least likely: basically, that John McCain is right when he says that "there has been significant progress toward a bipartisan agreement" on the bailout. The facts, of course, is that he isn’t and there hasn’t.

The second theory is that liquidity injections by global central banks, after signally failing to work for the past 14 months, have suddenly started working. That seems improbable to me, too — if anything, central banks are now lending so much money so freely into the banking system that there’s little if any need for banks to lend money to each other. Extra liquidity, in such a scenario, can increase interbank rates as easily as it can decrease them.

The third theory is the least unlikely and the most hopeful:

Maybe we don’t need the bailout, at least not in the this-must-happen-tomorrow-or-we’ll-all-die sense of late last week. By acting to backstop money market mutual funds, and magically transforming the last two big investment banks standing–Goldman Sachs and Morgan Stanley–into banks, the government already addressed the two big panic button issues of last week. And now most all the remaining financial institutions that anybody might have serious worries about are within the banking system, where we have pretty well-established rules for dealing with insolvency and experienced civil servants who administer them. Not problem solved–nowhere near–but problem steered in a direction where it could conceivably be resolved without emergency legislation right now.

I devoutly wish this were true; I put it at p=0.5, or thereabouts. But even if it is true, it would only represent a slight change in the thing that the bailout is designed to avert. Rather than immediate and certain financial chaos in the event the bailout doesn’t happen, we’d just have contingent and could-happen-at-any-time financial chaos. Which is an improvement, but not much of one.

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