The firestorm that has blazed through global credit markets since August will smoulder for months and is widely expected to take a toll on the currently robust world economy well into 2008.
With British mortgage lender Northern Rock the latest financial institution to require emergency central bank help, any hopes of a quick return to normal financing conditions have received a severe dent.
Whether the news of Northern Rock's woes constitutes a final exclamation market in the whole credit debacle or is the beginning of a more serious phase of problems for the sector is a question that we imagine was most troubling investors, said Neil Mellor, strategist at Bank of New York Mellon.
Few see much clarity emerging over the next six weeks.
Billions of dollars of pent-up refinancing from the August seizure still need to be negotiated, there is concern about what private-sector banks may reveal during the third-quarter earnings season and decisions from top central bank meetings also hang in the balance.
But it's the lack of a single hose to douse the flames that leads policymakers to accept this disruption will have a more durable impact on world economic growth than previous banking shocks -- such as the ones that followed Asia's emerging market collapse and Russia's default in the late 1990s.
U.S. Treasury Secretary Henry Paulson warned this week that the dent to market confidence boosting short-term borrowing costs by more than half a percentage point would not dissipate quickly. The European Central Bank echoed that on Thursday.
LESS AND MORE EXPENSIVE CREDIT
The picture of how all this happened is becoming clear but the solution to it remains murky.
Wholesale borrowing costs everywhere have soared following a crisis of confidence over the market value of battered U.S. sub-prime mortgages -- low credit-quality loans which have been repackaged, sold around the world and used as collateral for a host of further financing.
Typically routine asset-backed financing, which had increasingly been tapped by banks and many of their off-balance sheet conduits, seized up over the past month up as a result of the uncertainty.
Concern about how much money the banks will now have to stump up to keep these conduits afloat has forced them into hoarding cash that has typically been lent out to each other on the open markets, pushing global interest rates on London's interbank market skyward.
Unless confidence in asset-backed financing and the status of the many of the complex entities borrowing on those markets returns suddenly and quickly, those borrowing rates will stay elevated and be quickly passed on to businesses and consumers.
And if to restore that confidence, banks are forced to bring their sponsored vehicles back on balance sheet -- possibly as a quid pro quo for emergency cash stopgaps from central banks and regulators -- they will eventually curtail overall lending.
This reduction in total lending per se, on top of the higher market lending rates, will further drain economic activity.
Ultimately what's going to happen is that central banks will make the liquidity available to those who need it, but the price for that will not only be measured in basis points, it will be measured in terms of regulation and transparency, said Nick Parsons, chief market strategist at nabCapital.
A lot of this (lending through structured vehicles) is going to come back on to balance sheets -- whether by accident or by regulation. The banks will have to provide capital for it and it will reduce the capital that's available for lending.
NO QUICK FIX
The inability of central banks to quickly drag key three-month borrowing rates back down toward their target levels quickly is both an illustration of the problem and a reason why it will sap economic strength.
The central banks can control the very short-term overnight lending rates -- but they can't force banks to keep lending to each other for over one-, three- or six month periods without addressing the root cause of their reluctance to do so.
Faced then with this effective private-sector interest rate hike, the International Monetary Fund this week acknowledged it will likely have to revise down U.S., European and Japanese economic growth rates for next year.
In a Reuters poll published Thursday, private forecasters also marked down forecasts for the Group of Seven top economies -- ascribing a 30 percent chance of a U.S. recession next year.
Economists at Deutsche Bank, who believe a global recession can be avoided by timely central bank interventions, calculated the dual cost of higher borrowing costs and so-called credit rationing.
Using various simulations surrounding a shock to global economy of a 40 basis point rise in London Interbank Offered Rates (Libor) for the major currencies -- the extent of the rise seen since early August -- Deutsche said tighter credit conditions alone could lop 0.3 percent off world growth.
But they said that adding even conservative estimates of the effects of credit rationing could take at least 0.5 percent off global growth rates in total next year.
Indirect effects associated with quantitative restraints on non-price rationing, resulting from a tightening of lending standards and more cautious extension of credit by lenders, may well reinforce the direct effects and hence augment the losses in growth, the Deutsche economists wrote in a note to clients.