The most stunning graphic of the past few days shows the stock market's reaction to government attempts to rescue the financial system. Between Monday and Wednesday, the Federal Reserve unveiled five initiatives to unfreeze credit, and stocks slumped after each announcement. Meanwhile, in Europe, the story is the same: The series of deposit guarantees, bank rescues, partial bank nationalizations and interest rate cuts has yet to calm investors. To the contrary, market panic and apparent government panic have fed on each other. In Washington, the Treasury went from ad hoc bailouts to demanding $700 billion without saying how it would be spent. In Europe, rival governments tripped over themselves as they rolled out uncoordinated measures.
There is a silver lining, and a cautionary message, to this terrible week. The silver lining is that market panic has now overshot so much that there's at least a chance that it will subside. We have gone from grappling with genuine financial challenges-that mortgage loans are tumbling in value; that shrinking the excess borrowing in the financial system is bound to force asset prices down-to grappling with the exaggerated terror that nobody is to be trusted. Banks won't lend to each other or to healthy companies even for short periods. Companies that have pre-negotiated rights to borrow are calling in the money, not because they need the cash but because everyone else is hoarding it.