Investment Banks Downgraded As Credit Crisis Continues
The three major investment banks were all downgraded today by Standard & Poor’s and remain with a negative credit outlook as more write downs are expected. Some experts are predicting over a $1 trillion in write downs for credit markets before it’s all said and done.
Today’s news has probably put an end to the speculation that the Fed will raise interest rates before the fall to combat high energy prices. The Fed is quickly entering into a no win situation as fears of stagflation begin to take hold of the economy.
When a central bank has an uncomplicated recession to deal with, it can cut interest rates. When it faces a clear-cut case of inflation, it can raise them. The worst nightmare of any central banker – especially one with a tradition of political independence to defend – is stagflation, when raising interest rates to curb inflation will provoke a recession or deepen one that has already begun…
The economy sags under the combined weight of house price falls, consumer confidence at a 25-year low, the credit crunch and a still widening financial sector squeeze. Nonetheless, soaring prices for oil and other commodities, not to mention the higher cost of imports thanks to a devalued dollar, are pushing up inflation and (especially) expectations of inflation.
With the housing slump far from over it is a real possibility that the credit crisis could last well into next year. As long as home prices keep falling, all mortgage related assets will be at risk from defaults and foreclosures despite the Fed’s attempts to prop up the banking system.
Treasury yields fell to their lowest level since March when investors were coping with the Bear Stearns collapse. As investors shed risk and take shelter in Treasuries, the flight to quality is also mirrored in the general banking system.
Right now financial institutions don’t trust anyone except the Fed. They definitely don’t want to lend to each other and only to individuals with the highest credit ratings and because of this mortgage rates are creeping up again. With the mortgage market in disarray, any possibility of a housing recovery seems farfetched at the moment.
