I’ve been trying for days to form a perspective on what’s happening in global markets, without much luck. And I’m not talking to or reading anyone who feels very differently.

Stock markets are plunging again in Europe and Asia, indicating a growing concern with falling economic output and a coming global recession. The dollar and yen continue to strengthen. Oil and gold continue to fall. US Treasury rates are lower across the curve, but not as much as one might expect.

US stocks are participating in the rout overseas at this moment, as they did last Friday morning. But I’ll stop short of predicting this will continue in New York today, because on Friday that turned out to be a bad call.

Markets are essentially in a chaotic state. There is no sustained pressure from economic fundamentals anywhere in the world. I can’t think of any prior period in history to compare this to.

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This is a brief note to warn you all candidly that the news background for financial markets is very unfavorable this morning.

European and Asian stock markets are in free fall, down around 10% as I write. That’s not a typo. Trading in S&P index futures is limit-down, and has been halted in Europe. Unless conditions change in the next few hours, expect to see perhaps an 800-point loss in US stock markets.

The US dollar has strengthened to $1.25 against the euro (it was almost $1.60 earlier this year). The Japanese yen is at a six-year high against the euro. For different reasons, both the dollar and the yen benefit from the exceptional turmoil in all global markets, both financial and commodity.

As I predicted earlier this week, crude oil prices have fallen sharply on the news that OPEC has announced a larger-than-expected cut in production this morning in Vienna. They’ll be taking 1.5 million barrels a day of production offline. But demand is falling faster than they can cut supply.

For the first time in a lifetime of watching markets, I have to say that political risk plays a big part in this market turmoil. Generally, markets don’t care who runs Washington.

This time, everyone is staring at the possibility of a Democratic landslide, with not only the White House, but also 57 or more seats in the US Senate, which amounts to a practically filibuster-proof majority.

And both the Democratic Presidential candidate and the Congressional leadership have started floating outlandish proposals to remake America’s public finances.

They’re talking about enormous new fiscal spending, as well as tax cuts for 95% of the people. And they’re not shy about the fact that they consider business income (aka, “windfall profits”) to be their piggy bank.

It’s probably not a good time to be investing in anything that reflects the value of corporate earnings.

-Francis Cianfrocca

This story caught my eye because, ever since the acute financial crisis began around Labor Day, news about how China is handling it has been very sparse.

And that matters a great deal, because China’s reactions to the crisis are key to understanding whether the global financial system has fundamentally changed in recent years. The question, of course, being this: has the economic dynamism of the world shifted away from the United States? Or does distress here still cause major problems elsewhere?

Citic Pacific Ltd. makes steel and does some real estate development. Its shares are listed on the Hong Kong stock market, and its billionaire board chairman is one of China’s richest people.

Citic Pacific is 29% owned by Citic Hong Kong, which is a wholly-owned subsidiary of CITIC Beijing, which in turn is owned by the Chinese government.

You probably remember these guys. CITIC Beijing almost invested $1 billion in Bear Stearns, but Bear collapsed before the deal could close. And they invested $3 billion in Blackstone Group shortly before the latter went public and started falling in value. In short, and greatly to the annoyance of the Chinese authorities, CITIC have earned a reputation as “dumb money.”

So what’s the news item? Citic Pacific has lost about $2 billion, trading currency derivatives. (All money figures in this post are US dollars, not HK dollars. 2 billion USD is about 15 billion HKD.)

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There are always unintended consequences. And they’re always so easy to see in hindsight.

So the government announces that banks will not be allowed to fail. What do you do if you’re a rational investor? You reason that there’s a floor under the debt-securities issued by these banks. You figure you might be able to exchange them for honest-to-goodness Treasury paper later on.

So you buy up bank-issued paper. What do you sell, to make room in your portfolio? Fannie/Freddie debt, which costs more because it’s presumed to be safer, so it yields less. It’s something like a pair-trade, or an arbitrage.

Unintended consequence? Retail mortgage rates have shot up nearly a full percentage point in just the last few days. Which makes housing all the less valuable and exacerbates the underlying problem.

This is fun, isn’t it?

I’ll go out on a ledge and say that the financial world has taken a step back from the ledge.

A semblance of non-insanity has been apparent in capital and bond markets this week. Now that governments across the world have made credible commitments to prevent financial meltdown (defined broadly as chains of insolvencies among tightly-interconnected counterparties), the violent panic attacks of last week have been damped out.

Term LIBOR, which is a complex of interest rate benchmarks that has been seized upon by mainstream press people as an indicator of the health of the crucial interbank-lending market, has stopped rising. Most of the LIBOR rates have been inching (or millimetering) back from the insane, nonfunctional levels they reached last week. Three-month dollar LIBOR is down about nine basis points from yesterday.

This is still insane and nonfunctional, but at least we’re moving in the right direction.

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The major news this morning affecting financial markets is that the Treasury is making a drastic change in its approach to the current crisis.

You know about the $700 billion Troubled Assets Relief Program (TARP). As originally conceived, the idea here was to contrive ways of purchasing assets like mortgage-backed securities from banks and Wall Street firms.

The purchases were to have been done at an overvaluation. This would have effectively recapitalized the financial system, through the back door as it were.

This morning, however, the Treasury has announced a far more aggressive, and invasive, plan. They’ll be going through the front door.

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This post will be brief, as duty calls. You don’t need me to point out the broad carnage in financial markets this morning. It’s going to be a tough day.

Margin calls will drive a lot of selling. We may get a brief respite rally after all of the weaker hands get washed out. Time frame for this would be the next several weeks.

No news in capital markets. Everything is still locked up tighter than a drum.

The most disturbing new sign this morning is in the bond market. US Treasury debt has not rallied strongly this week, as you expect it to when times are tough everywhere else. The very front end of the yield curve is sharply lower, with T-bill rates again nearing historic lows.

But farther out the curve, Treasury securities are mostly flat to lower. In some cases, yield spreads between Treasuries and swap interest rates at equivalent points on the yield curve have become negative.

That is portentous and hard to explain. It could be nothing. It could be the market trying to digest a lot of new and unusually-structured issuance by the Treasury this week.

Or it could be the start of a global deflation. Pray that we’re not seeing the latter.

-Francis Cianfrocca

The news background is relatively benign this morning. Stock markets in Asia and Europe are stronger, after five days of relentless and at times violent selling. Credit markets are just as dysfunctional as ever, but not much worse.

There are several things to watch over the next several days: corporate earnings, global countermeasures to the crisis, and further aggressive actions by the Fed and Treasury.

The biggest weapon that the world has for combating the crisis is the balance sheet of the United States, and there were signs yesterday that the Treasury is starting to use it aggressively. That raises questions about who will be in charge of this when Henry Paulson leaves office in January.

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We’re now well into the third week of extremely disordered conditions in global capital markets, with no end in sight. The world’s stock markets have started to respond to the prospect that a long period of capital-unavailability will reduce economic growth.

Henry Paulson’s $700 billion rescue plan, which seemed so radical mere days ago, is now seen to be too little, too late. Had Congress passed the plan when they first received it, instead of questioning whether the situation really was this dire, we might have forestalled the worst effects.

At this point, however, the question is what policy tools, if any, are still available. Let me tell you about one.

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Here it is. That’s the Fed’s announcement of two new facilities.

The Commercial Paper Funding Facility (CPFF) will create credit, to be made available to a “Special Purpose Vehicle” (SPV), as authorized under Section 13(3) (the “unusual and exigent circumstances” section) of the Federal Reserve Act.

The SPV is authorized to purchase three-month dollar-denominated commercial paper from eligible issuers. There isn’t a lot of detail in the one-page Terms and Conditions document released by the Fed this morning, but what there is, I’ll explain to you now.

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So why is the stock market up this morning? Because the Fed released a plan under which they will become direct purchasers of term commercial paper.

CP, loosely, is a short-term borrowing (less than 270 days) by creditworthy businesses, and it’s unsecured more than half of the time. (Sometimes it’s secured by assets.) Over the last three weeks, issuance of CP has been severely impaired, primarily because the institutional money-market funds that are the key buyers of CP have been holding cash out of the market.

I haven’t read the Fed’s plan yet, but I’ll update this when I do. In essence, it appears that the Fed will literally step into the shoes of the private market and fund the short-term borrowings of American businesses.

The Fed is a bank now. Nothing like this has ever happened before.

How big? Well, the total CP market is more than $1.5 trillion, but the vast majority of that is in financial businesses and insurance. The industrial segment of the market is somewhere in the neighborhood of $300 billion. That’s the part that everyone wants to backstop, because it directly addresses recent fears that perfectly healthy businesses might start failing to meet payrolls due to lack of capital.

So what’s the question you’re asking? What will the rates of interest be? How can the Federal Reserve set the market for term financing without swamping signals from free markets?

Very good questions. At this point, the only available answer is Yes.

Updates as events warrant.

-Francis Cianfrocca

Now that we’ve gotten through an ugly spasm of political theater and legislative sausage-making and enacted the Paulson rescue plan, it’s time to ask whether it’s working, and how we’ll be able to tell.

As I’ve said before, there are two different crises in the financial world. We have an acute credit crisis that directly affects capital markets and is now in the process of creating a serious recession. But we have a longer-term solvency crisis that affects the ability of the financial industry to fund business expansion and consumer spending.

I’ve talked a lot in recent days about the credit crisis, which has now broken through into the media spotlight in a way that suggests it’s at or near its peak. You already know that when you start getting hot stock tips from grocery-store clerks, it’s time to get out of the stock market.

Well, when media types do woman-in-the-street interviews and ask people if they know what LIBOR is, you know it’s time to ask whether the credit crisis may soon abate.

At any rate, I’ll give you a roundup on the current state of credit and capital markets in another post. Today I want to look at the solvency crisis.

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The ground is shifting in the acute financial crisis that started around Labor Day, and erupted like a boil into public consciousness about three weeks ago.

While Congress continues its indecision over whether to respond with forceful measures, the crisis has begun to have a powerful impact on the Main Street economy. None other than Warren Buffett (who’s been around for a lot of years and has seen a lot of things) is calling it an “economic Pearl Harbor.”

The stock markets, which appear to be the main barometer that Congress takes its cues from, have been gyrating wildly all week. And the windup of Wall Street has been put on hold by the SEC’s short-selling ban.

But the credit and money markets, where real-world businesses get the day-to-day financing they use to buy materials and to pay their employees, are under extraordinary stress.

I’m going to talk about what are the risks in the system in case Congress passes the Paulson plan today, and in case they do not. I’m also going to tell you how to react to the Armageddon-scare stories that are now rampant in the press.

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Several of our conservative friends have pointed to the very large reduction in the LIBOR interest rate between Tuesday and yesterday as evidence that the credit crisis is easing.

LIBOR is one those arcane things no one but geeks should need to understand. It’s a notional interest rate published at 11:00 AM GMT every day in London. It represents an adjusted average of the “offers” of sixteen large London banks for various kinds of short-term loans.

The offer is the rate at which the banks are willing to lend money. (The “bid” is the rate at which a borrower is willing to borrow. The market is generally somewhere in between the bid and the offer.)

LIBOR is extremely important for reasons I won’t get into now. But the dollar-denominated LIBOR rates (overnight and three-month) are key indicators to the health of the credit markets.

On Tuesday, LIBOR (which ought to be below 2.5%, given that the Fed funds target rate is 2%) shot up to nearly 7%, from about 3.8% on Monday.

And it fell just as precipitously on Wednesday, back below 4%.

This is being taken by some as a sign that credit markets are unfreezing. But that’s not the case.

Tuesday was the last day of the third quarter. Demand for short-term cash is always unusually high at quarter-end, because banks need to close their books and square their positions. The Tuesday rate was a technical distortion.

If you take Tuesday out, dollar LIBOR has been marching steadily upward all week. Overnight dollar LIBOR dropped sharply to about 2.85% this morning (if memory serves), but this reflects enormous injections of central-bank liquidity more than actual market conditions.

Three-month dollar LIBOR is still far above normal, and that’s a better indication of the sickness of credit markets, as it relates to actual business activity in the real economy. We have NOT yet had a break in the tension.

-Francis Cianfrocca

Yesterday’s somewhat anticlimactic news from Capitol Hill was that the Senate passed a new (and disgustingly pork-laden) version of the Paulson rescue proposal. Asian stock markets fell on the news, although overnight-dollar interest rates also fell somewhat.

The action moves back to the House of Representatives, which is expected to vote on the new draft on Friday.

In failing to pass the previous version the other day, Speaker Pelosi laid just about the biggest egg one can imagine. She made herself look stupid and incompetent, which is bad enough. She also made a big contribution to a growing perception that Congress just doesn’t know how to do what’s right for this country.

And worst of all, she managed to delay action yet again on an emergency rescue plan that should have been passed ten days ago.

The stock markets rise and fall with the expectations for Congressional action. Significant sectoral rotation is now occurring in the stock market. Financial stocks are rising sharply with the prospect of additional capitalization from governments here and overseas. But industrial stocks are falling as evidence appears that the global economy just slammed on the brakes.

And in the meantime, the credit and money markets, where businesses go for near-term funding, are in a state of near-catatonia. And they’re getting worse with each passing day that Congress spends trying to play politics and cover their backsides at the same time.

The question which is now being asked in a few quarters is: ”Has Congress waited too long? Even if they enact the Paulson plan now, is it too late?”

Let me give you a brief description of how the credit freeze is playing out, and how it affects you.

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