America's Congress is not used to being second-guessed. But as lawmakers wrestled in the Capitol, world stock markets have been giving real-time odds on the Bush administration's $700 billion bailout becoming law.
After the plan's thrashing by the House of Representatives on Sept. 29, spurred on by voters' loathing of "casino capitalism," investors panicked. Yet as The Economist went to press Thursday, they were optimistic that, after winning the Senate's approval on Oct. 1, the plan would pass.
Even if it does, that should not be a cause for optimism. Look beyond the stock markets, especially at seized-up money markets, and there is little to see except bank failures, emergency rescues and anxiety in credit markets.
These forces are drawing the financial system closer to disaster and the rich world to the edge of a nasty recession. The bailout should mitigate the problems, but it will not avert them.
The crisis is spreading in two directions -- across the Atlantic to Europe, and out of the financial markets into the real economy. Governments have been dealing with it disaster by disaster. They have struggled to gain control not just because of the speed of contagion but also because policy makers, and the public, have failed to grasp the breadth and depth of the crisis.
By some measures, many European banks look more vulnerable than their U.S. counterparts do -- and that is saying something, given the past week's forced sale of Washington Mutual, America's biggest thrift, and Wachovia, its fourth-biggest commercial bank.
In America, outside Wall Street, the banks have lent 96 cents for each $1 of deposits. European banks have lent roughly 1.40 euro for each 1 euro deposited. They have to borrow the rest from money-market investors, who are not especially confident just now.
Some Europeans, including the British, Irish and Spanish banks, have housing busts of their own. And they must contend with the toxic American securities they bought by the billion, as well as their own slowing economies.
Western Europe is not the limit of this: the panic has also struck banks in Hong Kong, Russia and now India. And it is not just the geographical breadth of this crisis that is alarming, but also its economic depth. Because it is rooted in the money markets, it will feed through to businesses and households in every economy it hits.
Most of the time nobody notices the credit flowing through the lungs of the economy, any more than people notice the air they breathe. But everyone knows when credit stops circulating freely through markets to banks, businesses and consumers.
For almost a year the markets had worried about banks' liquidity and solvency. After the bankruptcy of Lehman Brothers last month, amid confusion about whom the state would save and on what terms, they panicked. The markets for three-, six- and 12-month paper are shut, so banks must borrow even more money overnight than usual.
Banks used to borrow from each other at about 0.08 percentage points above official rates; on Sept. 30 they paid more than four percentage points.
In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11 per cent, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.
Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks' assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.
This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business.
Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers no longer extend credit and loans will become elusive and expensive.
Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession.
Financial markets need governments to set rules for them; and when markets fail, governments are often best placed to get them going again. That's pragmatism, not socialism.
Helping bankers is not an end in itself. If the government could save the credit markets without bailing out the bankers, it should do so. But it cannot. Main Street needs Wall Street; and both need Washington. Politicians -- and President George W. Bush is the most culpable among them -- have failed to explain this.
Governments need not just to communicate, but also to co-ordinate. Past banking crises show that late, piecemeal rescues cost more and work less well. Ad hoc mergers work for a while, but demands for help tend to recur. Inconsistency sows uncertainty.
Cross-border banking can make one country's policies awkward for the neighbours: the Irish government's guarantee of all deposits threatens to suck in money from poorly protected British banks. France's suggestion on Oct. 1 that Europe's governments should work together was a good one; Germany's rejection of it was wrong.
Central banks have co-ordinated their liquidity operations. Now that oil prices have plunged and worries about inflation are receding, interest-rate cuts are possible. They would be more powerful if co-ordinated.
But it is not only central banks that need to combine. Whatever America's Congress does, governments should work together on principles to stabilize and recapitalize banks -- not just to stem panic but also to save money.
Even if, as the Europeans claim, the crisis was made in America, it now belongs to everyone.
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