Credit crunch from Wall Street to Main Street

Other than watching your 401k erode, it’s hard to relate to Wall Street’s meltdown. Here’s the chain of causation that leads from Wall Street to your wallet.

Right now, anyone with cash — whether banks or investors — is very leery about letting others touch their money. Banks can go under, companies can fold. So everyone with cash is dumping money into US Treasuries. The rate the government has to pay to keep people’s money basically dropped to zero yesterday, down from 2% Monday. (Today’s New York Times has a great graph illustrating this yield slide, but I can’t find it online.) Conversely, the rate that banks and companies have to pay each other for money has jumped 2 to 3 percentage points. AS the WSJ reports:

In the giant market for commercial paper, a reliable source of low-cost, short-term funds in normal times, the cost of borrowing shot up Wednesday. Traders said most lenders were unwilling to extend credit beyond a single day. Sears Holdings said it paid 3.6% Wednesday, about three-tenths of a point more than a day before, to sell $3 million in 30-day commercial paper. Ford Motor Credit Co., the finance arm of Ford Motor Co., paid 7.5% for overnight borrowings, according to one trader, who said the rate would typically be several percentage points lower. General Electric Co., rated one of the safest borrowers, paid 3.5% for overnight borrowing, about 1.5 percentage points more than would have been normal, this trader said.

This is called a flight to quality. An extreme flight to quality. How does this impact your life?

Most companies, even the most profitable, rely on short-term financing to bridge the shortfall that occurs between the time they spend cash to build goods (cars, houses, widgets) and the time when they sell those goods. Without this bridge of financing, companies reduce orders, lay people off and in extreme cases go out of businesses.

Companies don’t report their orders to the government, so it can take months for this contraction in orders to show up in government data.

But layoffs show up quickly. The first thing most people do after getting laid off is to head to the local unemployment office to file a claim for unemployment insurance. And initial unemployment claims is precisely the number that has been ratchetting higher for the last year. The prior week’s numbers are announced every Thursday at 8.30AM. Today the most recent numbers came out and were, you guessed it, worse than last week.

In the week ending Sept. 13, the advance figure for seasonally adjusted initial claims was 455,000, an increase of 10,000 from the previous week’s unrevised figure of 445,000. The 4-week moving average was 445,000, an increase of 5,000 from the previous week’s unrevised average of 440,000.

So watch closely next week.

When will Wall Street’s slide end? Just as markets often overshoot on the upside, they usually overshoot on the downside. Just as the market tops out when shoe-shine boys are giving stock-tips to millionaires, markets bottom when millionaires are the ones giving shoe-shines, and EVERYONE is depressed. Sadly, we’re a long way from that moment.

So, as ugly as this week has been — at least if you’re an investor in AIG or MS or GS or WB — watch out for a few more big really nasty slides and chasms over coming months.

There’s more to come in terms of nasty surprises about balance sheets. AIG had a much bigger hole in its balance sheet than everyone expected. The same for FNMA and FRMC. There are lots of other holes out there, and right now capital is rushing away from those holes, both real and imagined, as quickly as possible.

No amount of liquidity from solicitous central banks will force people to trust each other. We’re going to have to reach prices AND conditions at which greed overwhelms fear. After a 10 year binge of greed… those hormones are tapped out and its gonna take a while for them to build up again.