PAUL KRUGMAN: The Sum of Some Fears

[kevinmc]

Yesterday’s scary ride in the markets wasn’t a full-fledged panic. The interest rate on 10-year U.S. government bonds — a much better indicator than stock prices of what investors think will happen to the economy — fell sharply, but even so, it ended the day higher than its level as recently as mid-May, and well above its levels earlier in the year. This tells us that investors still consider a recession, which would cause the Fed to cut interest rates, fairly unlikely.

So it wasn’t the sum of all fears. But it was the sum of some fears — three, in particular.

The first is fear of bad credit. Back in March, after another market plunge, I spun a fantasy about how a global financial meltdown could take place: people would suddenly remember that bad stuff sometimes happens, risk premiums — the extra return people demand for holding bonds that aren’t government guaranteed — would soar, and credit would dry up.

Well, some of that happened yesterday. “The risk premium on corporate bonds soared the most in five years,” reported Bloomberg News. “And debt sales faltered as investors shunned all but the safest debt.” Mark Zandi of Moody’s Economy.com said that if another major hedge fund stumbles, “That could elicit a crisis of confidence and a global shock.”.......

http://freedemocracy.blogspot.com/2007/07/paul-krugman-sum-of-some-fears.html