Finally, A Meaningful Step to Deflect Disaster?

Doomsday observers may yet meet their match in the form of government officials. I confess to being astonished at how quickly the authorities are acting on behalf of the financial system, even though they're often acting carelessly.

From the Wall Street Journal:

• The U.S. is weighing two dramatic steps to repair ailing financial markets: guaranteeing billions of dollars in bank debt and temporarily insuring all U.S. bank deposits.

Guaranteeing bank debt is the more important of the two, because this step would probably forestall some payouts on credit default swaps (CDS), which far exceeds the value of the bank debt, and which is the black hole in the financial system right now, a major reason why banks won't lend to banks. There is roughly $55 trillion in CDS, the insurance that many financial institutions have promised to pay to holders of corporate debt (for a fee). If the government prevents banks from defaulting on debt, then other financial institutions who issued the insurance against this probably won't have to pay-up to the holders of the insurance. As a result, such a move by the U.S. could help prevent some bank failures and restore some confidence to the banking system.

A U.S. move to this effect would appear to follow a U.K. plan, and if it went into effect, it would show how quickly the international community can learn from each other, if they choose to. Coordinated global action is the only thing that can deflect financial system collapse, so greater signs of real cooperation could slow down equity markets' retreats.

There's another piece of slightly reassuring "news" out there. We're reading that the $700b U.S. "bailout" plan may, after all, allow the U.S. government to "recapitalize" U.S. banks -- i.e. buy a stake in them in order to facilitate trust in them. A major criticism of the bailout has been that the U.S. should have done this.

But as we've explained in prior posts, we're not tempted to raise equity exposure from our current 1/3 of our long-run strategic objective.