Felix Salmon

Your daily TED update: 457bp. Just to put things in perspective, a little, on a day when European and — surely — US stock markets are going to rise a lot. But I do think that the optimism (or retreat of utter pessimism) is justified, if the UK’s plan is more generally adopted across Europe and the US.

Robert Peston has a nice summary of the details: not only are there huge equity injections into banks, alongside a promise of unlimited short-term liquidity, but the UK government is forcing the banks to lend at 2007 levels, not only to each other but into the real economy. And the total capital being raised today just in the UK has reached an astonishing £50 billion.

I was right about the pound: all that money flowing into the UK has helped it rally sharply this morning, from $1.70 up to $1.74. That’s great news: a vote of confidence in the UK’s plan, which should make it much easier for other countries to follow suit.

Also in good news: the Morgan Stanley-MUFG is going ahead, on revised terms.

To be clear: none of this means that we’re not entering the worst recession of our lifetimes. Corporate earnings are going to fall, and the more leveraged your company is, the more pain it’s going to be in. Many stocks will grind lower from their present levels as the real economy bites. But I am hopeful, this Monday morning, that the days of broad-based stock-market plunges are behind us — or at least that they can be, if the rest of the developed world follows the UK’s lead.

While all eyes were on Washington this weekend, who would have thought that the real breakthrough would happen in Paris?

European financial and political leaders agreed late Sunday to a plan that would inject billions of euros into their banks in a bid to restore confidence to the teetering financial system.

Taking their cue from a rescue plan announced last week by Britain, the European countries led by Germany and France pledged to take equity stakes in distressed banks and vowed to guarantee bank lending for periods up to five years.

Spurred into action by the heads of state in Paris, the finance ministers in Washington even managed a useful contribution themselves:

The world’s leading industrialised nations have pledged to do everything in their power to prevent any more Lehman Brothers-style failures of systemically important financial institutions…

There is unanimous agreement that the global system in its current extremely stressed state could not take the collapse of another systemically important firm such as Morgan Stanley, which came under attack last week in the markets.

This is much more important, for Morgan Stanley, than any cash injection from MUFG, no matter how it’s structured. The G7 is essentially telling market-makers that they can write credit protection on Morgan Stanley with impunity: they’re not going to let it go the way of Lehman Brothers, with all the systemically-disastrous messiness that would entail.

This is by no means an overnight solution to the crisis. Markets are going to remain jittery for the foreseeable future, and it will take years rather than hours for banks to start implicitly trusting each other again. Bonds of trust, once broken, are not easy to restore, and in the near term banks are going to continue to borrow from central banks rather than from each other — thereby keeping Libor, and the TED spread, elevated. But as Steve Waldman notes,

To the degree that LIBOR does not reflect banks effective cost of funds, an elevated rate can be viewed as a hidden tax of the nonfinacial sector by banks.

In other words, banks aren’t just getting public-sector billions and government guarantees, they’re also getting much wider profit margins on all their Libor-linked loans. With luck, that will make them profitable enough that they can start buying back their equity from their governments within a couple of years.

The indicator to watch, I think, is the senior debt of TBTF financial institutions. If the G7 statement is reliable, the Pimcos of the world are going to start loading up big-time on senior debt from the likes of Citigroup, RBS, and Deutsche Bank. And since the equity markets are taking their cue from the debt markets these days, if those spreads start coming in, that could mark an end to the carnage on Wall Street. Not a bottom, necessarily, but it might at least utter in a period where people can start breathing again.

Steve Waldman asked on Saturday:

Why did Ben Bernanke, widely respected among economists as both a scholar and gentleman, support a rescue plan that very few of his colleagues considered "first-best" or even "second-best"? While there was no firm consensus among economists about precisely what ought to have been done, a plan based on no-strings-attached purchases of difficult-to-value assets by taxpayers was particularly surprising…

Here’s a possibility: … In order to pursue the policy [the Fed’s] technocrats thought best, it required large-scale funding from the US Treasury. Dr. Bernanke had to negotiate with Secretary Paulson, whose nickname "The Hammer" is not a tribute to his love of carpentry.

And the NYT seems to confirm Steve’s suspicions on Sunday.

People familiar with the early planning efforts for a systemic bailout said the chairman of the Federal Reserve, Ben S. Bernanke, argued that it would be easier and more efficient to inject capital directly into banks. But Treasury officials balked, in part because they were ideologically opposed to direct government involvement in business.

Brad DeLong talks about "the Fed, the Treasury, and major U.S. financial institutions having a bar fight on the Titanic" — and the differences between the three are becoming clearer. The Fed seems to be in the Gordon Brown camp; the banks are happy to take federal capital injections but don’t want any kind of restraints on pay and don’t want existing shareholders to be wiped out. And Treasury? Well, at this point it’s unclear what exactly Treasury intends to do, although consensus seems to be moving towards the idea of using the TARP to recapitalize the banks, while outsourcing to Frannie the original TARP function of buying distressed assets.

The good news, then, is that the three parties here (never mind Congress, it’s had its say, and will have very little further input in the immediate future) are moving to more or less the same place. The bad news is that getting here took far too long, and the parties are moving too slowly, and now it might be too late: the stock market is open on Monday, even if bond markets aren’t, and Morgan Stanley, for one, is in the crosshairs. Paulson’s like Tommy Lee Jones driving in to the motel in No Country For Old Men: even if he was able to prevent a bloodbath, which is far from obvious, it’s too late anyway.