ABC News’ Betsy Stark reports: Another day, another meltdown, another historic response by policymakers.
Will this morning's coordinated global interest rate cut stop the panic selling in financial markets around the world? The immediate reaction was positive but can it hold? That's a tall order right now. Fear is pervasive and the facts are pretty bad, too.
While you were sleeping, Asian markets went into a tailspin. Japan's Nikkei recorded its worst one-day drop -- almost 10 percent -- since the stock market crash of 1987. The bloodletting continued in Europe, despite the announcement of an extraordinary financial rescue plan by the U.K. government. British Prime Minister Gordon Brown called the bank bailout plan -- worth close to $1 trillion in direct loans and guarantees -- more "comprehensive" than the measures taken in the United States.
Elsewhere on the globe, Iceland is trying to avoid national bankruptcy with an emergency loan from Russia. But Russia's stock market has been in such steep free fall, trading there has been suspended until Friday.
Despite aggressive, inventive and massive interventions by the government in financial markets, investors are in panic mode. What should be working to allay fears and restore confidence is not. Some market analysts say it's a sign that the bottom of this terrifying plunge could be near.
But for now, a vicious cycle has taken hold: The worse the financial crisis grows, the more it harms the economy, the worse the financial crisis grows.
Consider the vicious cycle at work in the credit markets. The Federal Reserve steps in to say it will lend directly to big companies that can't get short-term financing for payroll and inventories in the commercial paper market. That's after setting up a special credit line of nearly $1 trillion -- a "liquidity backstop" -- to encourage banks to lend.
But banks are still not lending. Lending rates have still not come down. Why?
It's not just that banks are fearful that their counterparts will not be able to pay them back -- even when they're the size of General Electric, Toyota and American Express. Banks are also hoarding cash because in such treacherous times, businesses stay afloat by drawing down long-standing lines of credit they have with banks. And if banks signal they no longer have the cash to honor those lines of credit, there will be real risk of a run on the bank.
The shutdown in lending, in turn, means businesses are starved for capital. They postpone all but the most vital expenditures. But if sales and profits decline, eventually companies will look for other ways to save money. That's when unemployment rises. If unemployment rises, consumers hunker down even more. That causes the economy to slow. If it slows enough, some businesses will fail. If more businesses appear to be at risk of failure, banks will be more fearful of lending to them. This is what a vicious cycle looks like.
Is there anything that can break this vicious cycle? The talk in the markets has been about the need for a coordinated global response to this global financial crisis. The thinking is that with financial institutions around the world so interconnected and so collectively exposed to risk, the most effective fix is not a piecemeal approach, country by country, but a coordinated one.
The markets now have what they have been saying they wanted. We will soon see whether it's enough.