Investors fear governments can't stop recession

By John W. Schoen, Senior Producer

Global stock markets are falling in lockstep this week because investors all share a common fear: The world is slipping back into recession and governments around the world are powerless to stop it.

Two years after the world emerged from the worst financial collapse since the 1930s, a repeat is looming. European Union officials have been unable to forge a political consensus among its 17 members to head off a debt default by Greece. Some of Europe's banks won't have the capital to withstand the expected losses on their holdings of Greek debt.

European leaders are now preparing for an "orderly" default, according to published reports.

Though they've cobbled together a fund to backstop Greece's $500 billion debt, it's not enough to cope with a possible default four times as big by Italy, which is in the early stages of the downward spiral that sank Greece.

"Greece is gone, the markets know that," Allan Sinai, chief economist at?Decision Economics. "We're now looking at Italy and Spain and the potential for Italy going. And that's what's so scary."

Scarier still is the growing sense that Europe's political leaders are powerless to stop the downward spiral. Despite repeated assurance that they are prepared to act, the European officials have been paralyzed by a deep political division over wealthier countries like Germany and France should bail out their weaker neighbors. As the crisis has deepened, the political divide has widened.

Leaders of the 20 largest economies, meeting in Washington this week, made yet another pledge to act.

"We are taking strong actions to maintain financial stability, restore confidence and support growth," the G-20 joint statement said. "We commit to take all actions to preserve the stability of banking systems and financial markets as required."

But there was little indication of any action to back up the statement.

The stock market appeared to find a bottom Friday after a week of heavy selling that wipe out?roughly?$1 trillion in market value as measured by?the?Wilshire 5000, one of?the?broadest market?indices. ?

In recent weeks, the strongest action has come from the U.S. Federal Reserve, which announced this week an historic, and highly unorthodox, program of reshuffling $400 billion worth of its bond holdings to try to push interest rates even lower.

But, because the plan is widely expected to do little to revive the stalled U.S. economy, the move only served to remind investors that the central bank has run out of effective options.

"The fear that it's all dependent on the Fed -- together with this mess in Europe -- is really getting people more and more worried, unfortunately," Jim O'Neill, chairman Goldman Sachs Asset Management, told CNBC. "And there's just no sign of any true leadership in Europe."

The problems that those leaders now face would be daunting even if a political consensus could be reached. Massive debts taken on be Europe's weaker countries have slowed growth, raising investor fears that those debts may be unsustainable. Those investor fears have forced interest rates higher, raising borrowing costs, forcing deep budget cuts, which accelerate the economic contraction. The downward spiral is now feeding on itself.

"If you take the debt of the periphery countries, combine them with the bank debt because they're joined at the hip, you come up with a number of about 5.5 to 6 trillion euros," Sean Egan, an analyst following the debt crisis at Egan-Jones Ratings Company, told CNBC.

Even if only a third of that debt goes bad, said Egan, it's more that the stronger European countries can manage.

"Germany, which is held up normally as a savior, has total debt in the area of 1.5 trillion euros ($2 trillion)," he said. "It's unlikely they're going to be willing to double their debt to bail out the periphery countries. That is the basic problem."

In the U.S., Congress and?the?White?House?remain deeply?divided?over how to close a $1.4 trillion budget deficit, having succeeded in only?in postponing the day of reckoning until year-end. That process will only become more difficult as a deeply partisan presidential?campaign intensifies the debate.?

Compared to their European counterparts, U.S. banks are relatively well capitalized to withstand another financial crisis. And, despite recent attacks by Republican Congressmen and president candidates, the Federal Reserve remains a lender of last resort to U.S., ready to backstop the U.S. financial system if another meltdown were to happen.

American companies, having paid down debts and raised mountains of cash since the Panic of 2008, are also better positioned to weather another financial shock.

But with a housing market mired in a four-year recession, unemployment at levels not seen in decades and governments around the world slashing spending, the global economy would enter a new recession in much worse shape than the downturn of 2007.

That recognition has brought an abrupt change in investor thinking about how well companies will fare if they're entering a much more difficult economic environment.

"Corporations were generally be happy about life in late August early September '08 as well," said O'Neill. When the financial system really imploded and financial firms stopped extending credit to anybody, the corporate world had to destock and we know what happened after that. We are not far off the same sort of thing."?

Source: http://bottomline.msnbc.msn.com/_news/2011/09/23/7921158-investors-fear-governments-cant-stop-new-recession

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