First, there is a distinct difference between the credit market and the stock market. The stock market, is all about owning equities, while the credit market, is all about owing debt.
So if you pattern the global economy as a functional human body, then “the Stock Market”, can be viewed as the body’s internal temperature, while the “credit or lending market”, can be seen as the body’s circulatory and breathing system. When your body experiences its temperature to rise and or fall rapidly, (The Stock Market), that clearly indicates that there’s some type of problem in the body. The fluctuations are the end result and are not however the direct cause of the problem. Usually taking a couple Tylenol will temporarily solve the problem.
The Credit Market on the other hand, acts a lot more like the circulatory system throughout your body. It is the generator that operates: the major organs in the body, liver, lungs kidneys etc. or industries, businesses and consumers. What it does is keeps all the organs in the economy, healthy and functional. But when you shut off or start to stop the blood supply, even just a little bit, all the vital organs will start to slow and eventually shut down. If one of the organs fail, that will eventually lead to another vital organ failure until the whole body or economic system eventually enters a death spiral.
That is exactly what happened in the Great Depression of 1929. The credit markets are well on their way to seizing up because the major banks just don’t trust their solvency, and vice versa. This distrust has the full potential and is capable of throwing the entire economy into a complete coma. This seized and frozen credit market has caused is investors to lose well over $2 trillion dollars in their blue chip stock market portfolios, all this since the beginning of September. So the root cause of the suddenly falling body temperature is a direct result and cause of a failing circulatory system.
So another analogy and example is that say a body limb, your arm or leg loses all circulation. The end result is it may have to be amputated, painful, but you still get to live. If you just leave it alone and don’t bother treating the circulatory system problem, it could result in death. When Fannie Mae, Bear Steins, AIG and Freddie Mac were recently rescued, that was like one of the legs were amputated, handicapped but still overall functional. The end result is, what’s required is a good systemic solution, the most obvious is getting rid of these bad mortgages in the portfolio and turning them into better assets. Easier said than done.
Recently when Merrill Lynch downgraded the entire agriculture sector, the result was the S&P composite index fell a dramatic 803 points, this by some analysts was called “irrational” and “scary” behavior. Experts in the financial sector claim there are over $160 trillion dollars currently sitting in credit default derivatives, all on blue chip company books. This clogs up their balance sheets which directly affects earnings as well their stock prices.
When the government decides on a bailout, it is like one of those electrical shocks to jolt the body back to life. It may temporarily keep the patient or economy alive, but the patient is still not feeling very good.
The long term fix is to have all the world major banks to get the credit circulating again. Then businesses will once again be able to borrow and expand their businesses by buying capital and hiring employees, who will in turn do their part by getting loans from the bank to buy buy cars and build houses and successfully pay them off. Once these investors see the corporate earnings inching itself up again, they can then start putting their cash back into the stock markets.