Author: CIBC World Markets - Benjamin Tal
Article Date: October 17, 2008
By now there is little doubt that the current financial crisis is the worst we have seen since 1929. And it’s not over yet. But there are already a few signs that suggest we are closer to the end of the crisis than at the beginning.
First, US house prices—the trigger of the current crises—are still falling, but the pace of the decline is moderating. Earlier in the year house prices in the US were falling by more than 2% a month. Today they are falling by 0.5% a month. And at this rate, US real estate prices will stop falling altogether by early next year. That realization will provide the market with the necessary injection of confidence that the housing crisis is indeed about to reach bottom.
Second, what distinguishes the current situation from previous crisis is the speed and determination at which policy makers have been reacting to ease the credit crunch. The policy steps taken since early September were designed to achieve three key goals: to shore up capital position of financial institutions; to provide liquidity to money markets; and to support business and household confidence in the financial system. By far the most significant step was that the US Treasury will use $250 billion of the $700 billion authorized in the Trouble Asset Relief Program (TARP) legislation to take equity stakes in the nation’s banking sector. This should notably improve banks’ ability to borrow from each other and extend credit to households and businesses.
While each of these policy steps is a necessary condition for an eventual recovery, none of them is a sufficient condition. Along with potentially addition cuts in interest rates, the cumulative effect of those policy steps should pave the way for a noticeable easing in credit spreads. But they will fall short of pulling the economy out of a recessionary territory. In fact, slowly the market’s focus will shift from subprime related losses to the real economy. And for the next six months, the economy will provide soft numbers.
To be sure, the next six months will be difficult. The economies in both the US and Canada are probably in recession, and we probably will not see a sustainable recovery before mid-2009. However, current market valuations and credit spreads price in even a more severe scenario. To the extent that policy steps to date will work to stop the bleeding in the credit market, the recession might end up being milder than currently discounted by the market. In such a case, look for some recovery in equity markets at one point in early to mid- 2009.
