The worst month on the market in memory, for me and likely for other investors, occurred just in the aftermath of the Lehman Brothers bankruptcy between 15 September and 12 October 2008, when the G20 meeting brought a solution to stabilize markets.
This period was characterized by end-of-the-world sentiments, bouts of enthusiasm in sudden relief rallies and then darkest thoughts about the future. The intraday volatility of the stock markets was mind-boggling, losing 5% from the bell, then dashing far into positive territory by noon and nevertheless closing a couple of percentage points down.
It seems that in the last two weeks we are reliving that market environment. The intraday volatility on equity markets is again staggering. On Tuesday, 9 August the DAX (the main German equity index) opened with a mini rally of almost +1.8% against the previous close, went down to a severe –7%, but finished at almost the same level as the day before.
One cause of these extreme market movements is similar to what drove those in the fall of 2008: serious doubts by investors that the political sphere can solve the extant problems. Back in 2008 the task was to stabilize the distressed financial intermediaries both in the US and in Europe. Especially the US struggled – remember the first vote by Congress on TARP? Only after the G20 meeting in mid-October 2008 did an internationally coordinated approach tackle the problem and basically bail out the most exposed banks.
This time around it is Europe which lacks a solution to end its sovereign debt problem. True, the awful debate on the debt ceiling issue and the subsequent downgrade of the US credit rating by Standard & Poor’s last Friday contributed to the latest market turmoil, but one can say now that until the Presidential elections next year, the US debt issue is on the sideline. Moreover, one can rely on the Federal Reserve to prefer pragmatism over dogmatism.
The same is unfortunately not true for Europe. In my view, market participants are unconvinced that the sovereign debt issue is being addressed correctly, or more worrisome, that European decision-makers grasp the full extent of the problem. Talk of more austerity might reassure markets short-term, but if the austerity measures become too extreme they are not credible anymore. It also seems that European politicians are always fighting the last battle instead of focusing on the current one. This “being behind the curve” attitude exacerbates the crisis, which has spread now from the periphery (Greece, Portugal, and Ireland) to countries considered to be “too-big-to-fail” like Spain and Italy.
The European Central Bank is trying to mitigate the crisis. Buying Italian and Spanish bonds on a large scale has significantly reduced the interest rates of those two countries from over 6% to a more sustainable 5%. But first and foremost, the latitude for maneuvering is smaller for the ECB than for the Fed due to institutional design, and secondly there is strong dissent about policy within the ECB directorate.
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