The financial crisis continued to escalate in the past week. US equity markets have fallen to their lowest levels since 1997, credit spreads are widening and Emerging Markets are under renewed pressure. The latest problems started on 12 November, when US Treasury Secretary Hank Paul-son announced a change in how the remaining money from the USD 700bn TARP rescue package would be spent. Paulson stated that the Treasury would use the rest of the money (USD 400bn) to support the ailing Asset Backed Security (ABS) market. This is the market where car loans, student loans and credit card loans are sold to investors. The initial chunk of rescue finance was used to pump capital directly into the banking system. However, the latest deci-sion means the US Treasury has totally abandoned the original purpose of the rescue package, which was to buy 'troubled assets' (sub-prime related mortgage assets) from the banks in order to remove the risk of further write-downs stemming from these assets.
Paulsen's decision led to a major sell-off in the US mortgage market - not least the sub-prime CDO tranches (see ABX indices). The ABX indices have previously provided a good guide to future write-downs in the banking sector. Hence the recent declines will likely lead to more write-downs and thus a need for further capital injections into the banking system. With private investor interest still very muted, this capital will most likely have to come from the government. Hence there is much to suggest the need for another rescue pack-age with additional money from the US Treasury if panic is to be avoided. Grabbing the headlines in the past week was Citigroup - once the largest bank in the world - which suf-fered the biggest ever one-day drop in its share price on Thursday on fears that current measures are not enough to stop the downward spiral. A solution for the US auto indus-try, which is fast running out of money, is also much needed if some sort of calm is to return to the markets.
