Well the 20% drop I predicted in December has happened pretty quickly but that’s coming off a big high. We’ve had liquidity injections, stimulus packages and now an emergency rate cut of 75bps.

So far so good but what happens next?  Well if this was a standard asset bubble/recession I would imagine a lowering of rates globally, a bond market rally, a rise in unemployment and so on. But this is different because its really a money crisis.

I say money instead of credit because to all extents and purposes money is credit. But whereas money is secured on confidence, credit is secured on assets. Those assets are now worth a lot less than previously imagined (another word for risk analysis!).

We’ve seen some major US banks bailed out, a major UK lender go bust and be bailed out and a complete collapse of the US sub-prime market. The stock market reaction is simply an inevitable response. But don’t let that distract us from the real crisis which is global financial insolvency.

So the next issue will be a major US (or other) financial institution going to the wall. I mean a big player simply collapsing. To prevent this the Fed and other central banks will have to underwrite the whole system of interbank credit. A major collapse simply cannot be allowed to happen.

We may not even hear much about it but right now credit lines are frozen solid and at some point that pressure will cause an explosion somewhere.

So I wouldn’t be getting too excited about cheap assets just yet

Tags: banking, central banks, credit crunch, federal reserve, financial crisis, intervention, markets