End of Bearish Road? - A short-term recovery in sight?

Over this weekend confusion has set in on the rescue package that was "finalised" last week regarding the troubled Hypo Real Estate Bank. Europe is now desperately trying to find a strong fix to the problems arising in its zone. In the US the TARP is likely to roll out in the next 7-10 days after its successful legislation.
The accomplishment of TARP passage represents a turnaround of the legislative opinion and a willingness to challenge public opinion. But, the true size of the problem is now becoming clear to all. Banks are panicking and have hoarded liquidity (whatever is with them) and have been borrowing/lending for overnight tenor at atrocious rates.
The steps taken by various Central Banks have not yet addressed the fear factor of banks. Already Central Banks and their Governments have forcefully merged weak entities with stronger entities, guaranteed liabilities of banks, worked on bail-out funds and considered capitalisation of banks. Serious thought is being directed at giving up the Mark-to-Market accounting.
Out of all, the last one is the most simple to achieve. That is being mistaken for effectiveness. In the current panic conditions, when markets have all but closed down, prices are not representative of the unwind values or cash value of assets. The volume available for a price is very low and hence such prices are not representative of the liquidation value of assets of any respectable size.
Enough reasons exist for giving up the MTM accounting, but this is turning logic on its head - wasn't MTM accounting introduced in the first place such that Lenders could make their lending decisions with full information to determine the liquidation value of a firm? If liquidation value is not available any longer then are lenders to assume atleast full liquidation value of assets? Everyone knows what is happening to asset values now. So, on what logic would MTM accounting be removed? Would all banks now carry a guarantee from Central Banks/Treasuries that they would repay borrowings on time?
It is unclear to me whether lenders would prefer to lend blindly to borrowers after the withdrawal of MTM accounting? Would this lead to freezing of the system or greasing of the system? And when the MTM accounting is reintroduced would banks show up stronger or weaker?
The desperation to withdraw MTM accounting represents the extent of the problem. Central Banks will now have to play an increasingly direct role to ensure that liquidity returns to the markets. A coordinated approach across continents is still lacking. It is quite clear that the approach would have to cover capitalisation (including a debt/equity swap), funding, lowering capital ratios, putting weaker banks under special liquidity oversight. It appears that the withdrawal of MTM accounting is one esential ingredient in the solution to improve capital of banks.
It is quite clear that a complex solution would have to emerge.
Meanwhile, evidence of recession is emerging across the US and Europe. Banks are hibernating and unless the markets restart and credit flows again, a deep rooted recession will set in across countries. Stock markets are collapsing and the Dollar is holding on as more countries begin to be hit. The strength of Dollar is the hope that the US will have a short recession (as compared to other countries and in keeping with the record of last few decades) whereas other countries will flounder and will take longer to get out of recession. Since the problem is inexorably linked to the US and hence the Dollar, funding of those losses would have to be in Dollars and hence the big demand for the currency has led to the destruction of the interest rate parity across so many curreny pairs.
Indian Markets -
The NIFTY has rested at 3818.30 on 3 October 2008 very close to the low of 3816.70 seen on 16 July 2008. The ongoing crisis of confidence is likely to bring the NIFTY to 3626.85 last seen on 7 March 2007. I think this is where support will potentially emerge for the short to medium term. However, since negative news for the Indian economy is starting to filter in only in the last few months, I would not be surprised if the Index falls towards the 2550-2600 zone. That zone may be reached over some months if a deep recession sets in. Invariably, to meet that target, it is necessary that demand destruction happens in India over the next 3-6 months coinciding with a furthering of the pain and correction overseas.
The Rupee is also now reaching a potential support zone. It may be noted that the level of 47.40-47.60 is a potential zone of reversal, never mind the worsening external account. At this stage RBI should be expected to use its reserves to protect the exchange rate of Rupee. It will also be necessary to introduce other steps to control the depreciation of the Rupee. How about opening of more sectors for FDI? or increase in the limits for FDI in the various sectors?.
Interest Rates have also reached a possible peak in India. Here, while the positives have been very well noted by all I wonder if possible risks have been noted too. What about risks such as withdrawal of liquidity via the FII route? Would RBI provide liquidity through a CRR cut or a SLR cut? I don't think so. What about potential for larger issuance of securities by the Central and State Governments to fund deficits in revenues (due to the weak economy)? Nevertheless rates have possibly very little upside left.
I wonder if a recovery is at hand? See you next week!