Since the credit crisis struck 15 months ago, every government intervention to bail out the global credit markets has backfired. So don’t be surprised if the most recent Herculean efforts to reinvigorate credit markets backfire as well.
Temporarily, these interventions do calm investors to a degree. We see a decline in the premiums that lenders charge higher-risk borrowers. And we see a revival in the short-term money markets, especially commercial paper. But this initial success is consistently followed by even greater market panic.
For example, in August of 2007, when central banks injected hundreds of billions in new liquid funds into the banking system, and again, in March of 2008, when the U.S. Federal Reserve rescued Bear Stearns, the goal was essentially the same as today’s: To boost investor confidence in the credit markets.
In retrospect, however, it’s clear that the goal was often accomplished in a perverse way: Investors were encouraged to buy more shares in insolvent banks and more junk bonds of overrated corporations — despite the fact that bank balance sheets were continuing to deteriorate and the probability of major bond defaults was rising.
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