And Now Europe

The global selloff continued on Monday, as analysts watched the sort of market capitulation that wiped £93b off the FTSE-100 in London. Share prices across Europe, Asia, and the US continued to slide in spite of the rescue package President George Bush signed on Friday. Along with the bailout plan, the US government has recently increased currency swaps and raised the Term Auction Facility (TAF), risking more than $1t to steady the banking sector.

The markets are chewing up these liquidity injections at an alarming rate. Many analysts and dealers argue that banks are hoarding cash on expectation of pay-outs on up to $400b of credit-derivatives related to Lehman Brothers. At present, there is no central clearing house to address counterparty exposure in the trillion-dollar credit default swap (CDS) market. The opaque conditions surrounding financial balance sheets have compromised the sort of trust that drives short-term lending. 

On Monday, some $500b of derivatives contracts relating to Fannie Mae and Freddie Mac were settled, between 91.5 and 99.9 cents on the dollar. Many believe the recovery value on Lehman's bonds will not be as favorable, paying only about 10 cents on the dollar. The US Federal Reserve has scheduled a meeting for Tuesday and plans to unwind the CDS contracts by Friday. Perhaps then, banks might regain some confidence leading to a short-term financials bounce next week.

Whether or not today's losses reached an intermediate bottom, European markets continue to struggle with the ad hoc policies crafted by its members. Deposit backstops set up in Ireland and Germany have led to huge, destabilizing credit flows across the euroarea, as investors rush to security. The push to create a unified financial plan was endorsed on Monday when EU leaders issued a joint statement to "take whatever measures are necessary to maintain the stability of the financial system."

There are troubling signs that the financial crisis has spread well beyond the banking sector. Both the S&P GSCI index, which follows energy commodities, and the Bovespa Index, which follows commodity exports from Brazil, have collapsed during the recent turmoil. Until now, oil futures and emerging markets had been seen as a refuge from the credit crunch. Such losses will no doubt exacerbate the global crisis. 

The TED spread is still at record highs, and the volatility index touched a whopping 56.32 on Monday. There are reports that the Bank of England, the European Central Bank, and the Fed are all considering a coördinated rate cut. But their are certain hurdles: in the EU, there are stability and growth pacts that forbid large deficits, and in the US there are fears of inflation. Lowing interest rates might spur some sort of Pavlovian response from global investors, but there are still fears about long-term solvency of the payments system. 

As the crisis continues, the popular refrain is extended. When the US catches a cold, the world sneezes. But once the world catches a cold, the US is sure to get only more infirm.