Central Bank Moves

But even as the Treasury yields were falling, the London Interbank Offered Rate, or LIBOR, was on the rise to almost 4%, as banks’ risk aversion kicked up another notch and financial institutions demanded a premium for lending under the current market conditions.

Global central banks included the U.S. Federal Reserve and European Central Bank flooded the markets with hundreds of billions in short-term funds in hopes of restoring confidence to the short-term credit markets. The central banks have been making similar moves for months, boosting liquidity in hopes that the credit markets will return to normal.

“Are the problems so bad that they have to keep doing [this]? Is this just not working? These questions are not mutually exclusive,” Art Hogan, chief market strategist at Jefferies told Forbes. “The fact is the banks don’t trust each other, and a greater confidence level is needed to get banks to start working with each other.”

The Fed increased its existing currency swaps to $620 billion from $330 billion in an effort to make dollars more available worldwide.

“These steps are being undertaken to mitigate pressures evident in the term funding markets both in the United States and abroad,” the accompanying Fed statement read. “By committing to provide a very large quantity of term funding, the Federal Reserve actions should reassure financial market participants that financing will be available against good collateral, lessening concerns about funding and rollover risk.”

Looking Ahead

Ever since it became clear that the U.S. government’s decision to take control of foundering mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) was driven not by worries about the fading U.S. housing market, but by concerns that foreign central banks in China, Japan, Europe, the Middle East and Russia might stop buying our bonds, it was just as clear that the credit crisis was no longer just a domestic affair [For the full story on the U.S. government's decision to take control of Fannie Mae and Freddie Mac, check out this special Money Morning investigative report.]

The global implications of the credit crisis were demonstrated again yesterday with the early-day sell-offs in Asia and Europe. And it will likely be underscored again early today (Tuesday), after those overseas markets continue the record sell-off that took place yesterday on Wall Street.

Bailout-bill backers also will head back to the drawing board. And that’s not a bad thing, Money Morning’s Gilani said. Indeed, he believes lawmakers should craft a new plan, and then let the market decide if it’s valid or not since “there is no better way to test a new plan than to subject it to market reaction – period.”

“There is exceptionally good news in this turn of events,” Gilani said. “With the stench of politics and partisan airs out of the room, now, a better plan can be presented. There’s no reason why a new plan cannot be on the table tomorrow morning, vetted openly to the markets by Thursday and presented for a vote by Friday. The open vetting process will be reflected in the markets on an ongoing basis. What we’re trying to do here is calm and ultimately “fix” the markets. We need to listen to them respond to the medicine we are presenting.”

And since there’s no actual “plan” out there at the moment, Gilani says investors should once again look at “The Money Morning Plan” that he crafted an unveiled last week.

“My ‘Money Morning Plan‘ is the only plan that immediately can be vetted, openly and transparently, because it is not a political, partisan nor finger-pointing exercise,” Gilani said. “It is simple, easy to enact, easy to monitor, flexible, and the only plan currently circulating, in the world, that addresses the actual triad of culprits: the problem securities themselves; the credit default swap market; and relief for homeowners and taxpayers.”

Source: Surprise Rejection of Bailout Deal Causes Record Decline in U.S. Stocks, Paves the Way for a Better Accord

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