The Downside

The S&P 500 closed today at its lowest end-of-day level since October 2004 -- lower, even, than it closed on Monday. I spent much of the afternoon talking to perennial pessimist Bill Rhodes, at Citibank, who was keeping one eye on the markets; he's on the record as saying that this is the worst crisis he's seen in an international career at the bank which has spanned more than 50 years and which has been dedicated largely to crisis management.

Here's a datapoint to underscore just how bad things are: the markets plunged on a day when the WSJ had a front-page story about how the Fed is considering even more rate cuts -- the kind of story which is normally good for at least a couple of hundred points on the Dow.

But this crisis has clearly moved far past the point at which monetary policy alone can turn things around. The only real question is whether monetary policy and fiscal policy and TARP and regulatory reform and closer cooperation between global authorities can turn things around. Right now, I'd put that at about p=0.4.

Rhodes is an old Latin America hand, and talking to him I was reminded of the Argentina crisis of 2001-2. Argentina, back then, had a very smart economy minister, Domingo Cavallo, who had a lot of respect in the corridors of power globally but who was so concentrated on putting out fires along the way that he didn't see the magnitude of the crisis until it was too late. His huge government bill -- the "megaswap", it was called -- carried many hopes before it was passed, but turned out in very short measure to be too little too late. The result was a catastrophic economic crisis, with GDP falling by almost 11% in 2002 on top of a 4.4% decline in 2001.

Are things going to get that bad? No; I hope not, anyway. But the global financial system is so interlinked, and so susceptible to vicious cycles of mistrust and deleveraging, that the worst-case scenarios really are gruesome beyond imagining. Remember that, House Republicans (and Democrats, too), when the bailout bill comes before you for the second time.