Abridged Market Update: October 7, 2008
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The Emergency Economic Stabilization Act of 2008 was signed into law on Friday, October 3. The result was not quite what some had hoped.

Apprehension about its long-term effectiveness brought markets to their knees in recent days:

  • The Dow Jones Industrial Average (DJIA) closed down Friday by roughly 1.5 percent.
  • On Monday, the index lost nearly 3.6 percent on the day.
  • On Tuesday, October 7, the DJIA declined by another 5.1 percent to close the day at 9,447.11—a level not seen since August 2003.
Recent developments, and the market's reaction to them, foreshadow the likelihood of additional monetary and fiscal policy responses by U.S. officials, either with or without the cooperation of other central banks around the world.

A strong reaction from government may be required to help the economy regain its footing.

Key developments:
  • The U.S. House of Representatives reversed its earlier rejection of the proposed rescue plan and voted to pass an amended proposal on October 3.
    • The Treasury received authorization to purchase up to $700 billion of troubled mortgage-related assets from financial institutions as a means to remove bad assets from their books and provide stable, long-term capital, which the institutions can use to make new loans.


    • The main objective—to improve the availability of credit to mainstream America and ensure that qualified businesses and individuals can borrow funds at reasonable rates—is the key to stemming the credit crisis.


    • Other provisions include:
      • Raising the limit on the FDIC's insurance coverage on bank deposits to $250,000 from $100,000
        • Intended to restore faith in the banking system and prevent mass withdrawals
      • A focus on ensuring bipartisan Congressional oversight of the program
      • Providing the government with some flexibility in modifying the mortgages it purchases
      • Giving taxpayers some protection on the funds they invest
      • The extension of roughly $150 billion of various tax cuts, mostly unrelated to the issues of the day


  • On October 7, the Federal Reserve (the Fed) announced yet another measure to provide liquidity to short-term credit markets via a Commercial Paper Funding Facility.
    • The Fed will use a special funding facility to buy unsecured, asset-backed commercial paper for three-month terms from eligible issuers.
      • This begins to fill the current void where other lending institutions are either unwilling or unable to lend via the short-term commercial paper markets.
      • This is a major new initiative to restore normal functioning to credit markets, as it calls for the government to step into the breach, giving private financial institutions time to heal.


  • Restoring liquidity is a critical step, but other monetary and fiscal policy measures seem likely as well.
    • For example, the Reserve Bank of Australia announced a surprise rate cut of 100 basis points on October 7—dropping its target “cash rate” to 6 percent from 7 percent.
      • The move is likely the first volley by economic leaders to provide a jolt to the sluggish global economy.
      • The expectation is that interest rate cuts in the U.S. are probable—either at the next scheduled Fed meeting on October 28–29 or before.
      • There is much speculation that the move will be a coordinated effort by major central banks around the world.


  • While the Troubled Asset Relief Program (TARP) will purchase bad assets from financial institutions and provide some measure of additional capital, it may yet be insufficient. The government may well be needed to step in and provide more direct injections of capital into ailing financial companies—in similar fashion to Warren Buffett's Berkshire Hathaway buying $5 billion worth of preferred stock in both Goldman Sachs and General Electric.


  • In addition to monetary policy measures, such as liquidity injections and interest rate cuts, another round of fiscal stimulus by Congress will likely gain support in some circles if the economy fails to stage a meaningful rebound as more time passes. This may include Depression-era-type spending programs to:
    • Create jobs domestically
      • To possibly rebuild infrastructure or
      • Perform other projects for the public good
    • Create wealth and restore consumer spending
Recent market developments have been unsettling to say the least. But history teaches us that bear markets for stocks do not last forever, and such declines only serve to reinforce the benefits of holding well-diversified portfolios.

With the much-anticipated rescue legislation now passed, and the markets mostly shrugging off any positive effects and instead posting sharp losses in the immediate aftermath, the next step is to:
  • Closely monitor its execution
  • Assess its effectiveness
  • Scrutinize unfolding economic developments
One thing seems a near certainty at this juncture—the quite necessary interventions we have seen by the government thus far are unlikely to be the last.

- By John Blood, CFA, Chief Market Strategist, Commonwealth Financial Network

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks.

© Copyright 2008 Commonwealth Financial Network