A Gradual Cure

Story Highlights:

• Today's major headlines harp on economic concerns looking ahead, however much of the data used to make the case is backward-looking.
• To cure banking ills at the heart of the economic downturn, the Fed and government must follow a sensible order of operations for solving financial problems.
• After some major miscues, the government finally appears to be on a more auspicious path toward providing the foundation for the next stages of recovery.

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We know to regard cure-alls and quick fixes as mere snake oil—elaborate promises with questionable if not outright ineffective results. Yet when it comes to an ailing economy, most demand a quick and comprehensive remedy. Unfortunately, a lasting recovery will take time and involve a series of steps that necessarily must occur in a deliberate order.

There's no doubt the US economy is ailing. But it's less recognized that the foundation for recovery is being slowly built. Today's major headlines harp on concerns ranging from rising unemployment to mortgage delinquencies and foreclosures, however it's important to remember much of this data is backward-looking and can only tell us what happened in the US economy in the last month, quarter, and year. Generally underreported are the significant economic impacts of federal actions taken so far this year.

At the heart of the current economic downturn, or at the least a major aggravator, is the banking crisis. Frozen credit markets created problems that were increasingly catastrophic and widespread. Through this period, the Fed and government reacted quickly with various "rescues." Though at times their actions seemed (and some were) haphazard, they are now largely following a logical order of operations:

The Fed immediately provided central bank support to commercial banks by providing lending facilities to stave off immediate liquidity shortfalls. Next, the Fed and Treasury have worked to aggressively encourage interbank lending. The Fed then developed programs to stimulate external financing options for financial institutions. Newer programs target stimulating general corporate financing, securitization markets, and consumer lending markets.

The government so far appears successful in the first few steps, and these developments will provide the foundation for the next stages of recovery. Recent activity in the commercial paper market and corporate bond market suggest they are once again attracting private sources of capital. Falling yields on corporate bonds, credit default swaps, and insurance contracts on debt indicate increasing confidence in financial institutions. Liquidity is gradually returning to previously frozen credit markets. Notably, the S&P 500 Financials Index ended up 8.6% on Friday for the steepest advance among the 10 industry groups—tied to positive outlooks in the insurance industry.

At this point, subtle signs of recovery are dwarfed by new announcements confirming economic weakness. Plenty of folks are still looking for some grandiose solution to today's economic problems. But while destruction and disorder always seem to be accompanied by much noise and chaos, recovery is often deliberate and unannounced. The cure won't happen instantly, and there will be no moment of grand catharsis where an "all clear" signal triggers a spontaneous parade in downtown Manhattan. There will simply come a day in the future where things are functioning as they should, and few will even think to comment on it.