In a complete surprise, the US rescue plan (USD 700 bn to buy up illiquid mortgage bonds) that had been negotiated failed to obtain the support of the US House of Representatives, and was voted down 228 to 205.

 

The reaction was less surprising: the equity markets – still reeling from the string of bank problems that emerged that day – were shocked and closed significantly lower. The DOW JONES lost 778 points (the largest point loss in history!) and the S&P500 closed 8.8% lower. In the USA alone, equity market capitalisation dropped by around USD 1,200 bn yesterday. In today’s news, the DAX Future is already down 3.4% and the markets throughout Europe are guaranteed to open lower.

 

The massive reaction on the market should probably highlight the importance of the package to the US Congress. The US Treasury is now feverishly negotiating with congressional leaders to get a second vote on the plan, with the goal of bringing it through the House of Representatives with some minor modifications. But today is a holiday in the USA and thus there is no meeting of Congress. As a result, a second vote can only take place on Wednesday, but it is more realistic that it will only occur a few days later.

 

The package certainly does have its weak points (it does nothing for example to directly bolster the equity capital situation of the banks), and will neither prevent more banks from going bankrupt nor avert a downturn in the global economy. But even a faulty rescue plan is better than no rescue plan at all.

 

As this should probably become clear to the members of the US Congress who voted against the deal yesterday, we assume that the plan will finally be passed when all is said and done. Until then though the financial markets will remain extremely tense, and riskier assets should continue to feel the selling pressure.

 

What happens if no agreement is reached? It is still not the end of the world (not even for the financial industry). But the equity markets will probably settle at much lower levels and more US banks than necessary will run into problems. The downturn in the economy, which cannot be stopped anyway, would be much more severe.

 

As the outlook is dominated by purely political aspects right now, it is practically impossible to provide any recommendation with regard to the short term. Nonetheless, it does appear realistic to us that the latest massive losses on the heels of the plan failing to clear the first hurdle will be recouped just as quickly as soon as the package does find approval. Selling right now in a panic may soon prove to be a mistake. Over the longer term, crises of this kind are typically a good investment opportunity for a broadly diversified equity portfolio (even though the next few days may be anything but pleasant).

 

The opposite is true for the bond market: bond prices shot higher yesterday, borne by rising risk aversion, and from a short-term perspective the idea will be to take the profits in the next few days before the equity markets swing around again. Over the medium term, we still believe that bond prices should enjoy good support from the lacklustre economy and the downward trend in inflation, and hence any setbacks in bond prices due to a brief rally on the stock markets will probably be offset again in the months ahead.