Credit woes, bailout questions may stir volatility

By Tim Paradis

Oct. 6, 2008 12 AM PT

The Associated Press

NEW YORK —

The world’s financial markets face an uncertain and possibly volatile week as investors await details about how the Treasury will implement the government’s financial rescue package -- and watch for any further fallout from the credit crisis around the globe.

The markets have switched their focus to the world economy now that the $700-billion bailout plan has become law. And there’s reason for their concern: Governments across Europe are rushing to prop up failing banks. On Sunday, Germany said it would follow suit after Ireland and Greece guaranteed all private bank accounts.

Those are the latest signs that the troubles of U.S. banks, which have all but paralyzed credit markets, are affecting the financial systems of other countries.

Banks’ hesitation to lend to one another and to many businesses and individuals is the consequence of the bad mortgage debt that the financial rescue is supposed to sweep up.

But it’s still unclear how quickly financial institutions will be able to hand that debt to the U.S. government and convince the markets they are healthy again.

Wall Street may continue the volatility of last week when trading resumes today. Stock index futures declined more than 1% late Sunday, pointing to a lower open.

Doug Roberts, chief investment strategist at ChannelCapitalResearch.com, said the steps taken by governments abroad are welcome because a broad response, not simply the U.S. bailout, is needed to help steady the world’s financial system.

“A lot of the actions that are occurring overseas are good,” he said. “What you really need now is stabilization, and that really comes from the government.”

Roberts said the Federal Reserve and other central banks probably would continue to move in as needed to shore up the markets. But he thinks bringing lasting calm to credit markets and financial institutions will take longer to work out than many predict.

“I think that this whole bailout bill is the first step in a series of steps,” he said.

Still, he said policymakers probably would try to hold off on moves such as rate cuts until they have little choice. The fear, he said, is that the market could be unimpressed and policymakers would have few tools left to restore investors’ confidence.

“If one doesn’t work, what are you going to do for an encore?”

Roberts and other market watchers say it’s possible that the Fed, and perhaps other central banks, could cut interest rates this week -- ahead of its scheduled meeting at month’s end -- if the credit markets don’t show signs of life.

With oil prices well off their midsummer highs and indicators pointing to a slower economy, it’s easier for the Fed to justify a rate cut.

With so many unknowns, it’s likely to be a choppy ride on Wall Street for some time as the Treasury Department starts flexing its new powers granted by the financial rescue.

“You’re going to have a lot of volatility, and we’re going to get a whole lot of nowhere in the next few weeks,” said Frank Ingarra, co-portfolio manager at Hennessy Funds.

Investors will be straining to see how the Treasury goes about buying banks’ debt and what prices the unwanted assets might fetch. If the government pays too little, it risks sending more banks into failure by depleting their asset bases. But paying too much could artificially strengthen banks that made bad decisions in lending and hurt taxpayers.

“I think it’s a little bit more ‘Show me’ than ‘Tell me’ here,” Ingarra said, referring to investors’ desire to see proof that the debt locking up the credit markets was being absorbed.

Still, he contends the U.S. government rescue ultimately will help unclog the credit markets. “I think the bailout is huge. It will help us and help to mitigate the recession that we’re in or going to be in,” he said.

But even if the government’s hand can reanimate the credit markets, investors will still face tough questions about consumer spending and unemployment, the still-struggling housing sector and more.

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At a glance

Today

Weekly Treasury auction.

House Oversight and Government Reform Committee hearing on the collapse of Lehman Bros.

Tuesday

Federal Reserve releases consumer credit data for August.

House Oversight and Government Reform Committee hearing on the collapse of American International Group.

Energy Information Administration releases its winter fuels outlook.

House Education and Labor Committee hearing on the financial crisis and its effect on workers’ retirement.

Quarterly earnings reports are due from Safeway and Yum Brands.

Wednesday