Why did the market fall 777 points yesterday?
A quote from today’s Business Week captures the prevailing logic:
“Credit is the lubricant for the U.S. economic engine. If loans don't get made, businesses don't expand, orders don't get placed, workers don't get hired. A garden-variety economic slowdown can turn into a deep recession.”
OK, I get that. When the cost of capital goes up, growth becomes more expensive. And if the real cost of capital has shifted upward, valuations will shift downward, and who knows where that all ends? But did the world change so much just because Congress failed to make a one-time injection of $700B into the credit markets (some of which it will inject anyway through other means) that the long-term cost of capital changed? Or are we really worried about something else?
The same article stated: “If companies can't get funding in the commercial paper market, they won't be able to take care of basics, such as meeting their payrolls.” I’ve been hearing statements like this a lot the last few days. The experts seem to be saying that unless the short-term credit markets “unfreeze,” consumers and businesses alike will not be able to meet their day-to-day obligations. I don’t know about you, but I don’t rely on credit to meet my day-to-day obligations. And I’m not aware of many healthy businesses that do either. Sure, longer-term capital projects may be postponed in the current financing environment, but payroll? Are we really worried about consumers and businesses (other than over-leveraged financial institutions) facing bankruptcy because they can’t borrow more money? Were we all playing this kind of financial kiting scheme as part of some mass illusion of prosperity?
Yes, we are facing tough economic times. Yes, we will see real economic growth slow as we digest the excesses of the past few years. Yes, we will need to adjust to a world where spending bears a more prudent relationship to income and home prices are set by the demand of those who can actually afford them. Yes, these adjustments will mean corporate revenues, and thus earnings, will fall. Yes, as growth and earnings fall, so will jobs. But we knew all that before Congress voted yesterday.
So why did the market fall 777 points yesterday? Because we were hoping we would be allowed to ignore a bit longer what we all already knew. As a society, we have been living beyond our means. Being the sensible people we are, Americans told Congress yesterday it was time to stop. Even the stock market seems to understand that now. It’s time to go back to work and build real value. Nothing has changed in our fundamental ability to do that. S&P 500 is up 4% and climbing.
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