Stock Market Volatility, Subprime Loans, Credit Crunch Fears, and Our Global Economy

Here's my take on the current economic situation:

The U.S. stock market has reacted badly over the past few days to the global spillover from the U.S. subprime lending debacle.  Today a major French bank suspended withdrawals from three of its hedge funds that were invested in U.S. subprime mortgage-backed securities because the bank could not properly value these subprime mortgage related "assets".  This announcement fed global concerns about "liquidity in the system" - whether borrowers can borrow money in the future. 

As banks, hedge funds, and institutional investors lose money on subprime loans in the U.S. market (which once looked like such a great deal with their high interest rates - and that should have been a clear signal that they also carried a high risk of default), these traditional sources of credit to businesses may have less money to lend even to good borrowers.  In addition, lenders are tightening credit standards, making not-so-good-borrowers very concerned about their ability to borrow in the future.  Perception is sometimes what matters in the financial markets (at least until reality crashes in), so nervous corporate borrowers translate to nervous investors in corporate stocks, which translates to volatility in the stock market with people wanting to get out while the getting's good.

The European Central Bank stepped right in today, with an infusion of liquidity into their banking system, to calm fears and restore normalcy.  The Federal Reserve's FOMC, however, this week told us that they would not lower interest rates in the U.S.  The FOMC still says inflation is a bigger concern than economic recession.  However, if companies cannot borrow enough to keep their businesses and the economy growing, either because interest rates are too high to encourage borrowing or because lenders lose so much money in the subprime market that they don't have enough funds to lend, it becomes increasingly difficult to maintain a healthy economy.  Sustained losses in the stock market will also head us toward a recession.

President Bush assures us we have nothing to worry about.  I'm just not sure words alone are enough to restore stock market stability.

Stay tuned. . .

Here's a link to one report out of the many today:  http://money.cnn.com/news/newsfeeds/articles/newstex/AFX-0013-18792522.htm

(ag) Aug. 9, 2007, in Economy