Roubini: 'Much More Radical' Action Needed as Bailout Fails to Lift Confidence

The House passed the bailout bill Friday with much pomp, circumstance and by a wide margin. President Bush quickly signed it into law.
So how did the market react? If you have to ask, you probably can't afford it anymore.

Wells Fargo's bid for Wachovia and hopes the dismal September jobs number would spur the Fed to cut rates helped push the Dow as high as 10,796 ahead of the House's midday vote. But the index tumbled after the affirmative vote, closing down 1.5% to 10,325. Following a similar pattern, the S&P shed 1.4% and the Nasdaq lost 1.5%.

For the week, the worst for stocks since September 2001, the Dow lost 7.3%, the S&P shed 9.4% and the Nasdaq shed 10.8%.

One explanation for the market's reaction: The bailout won't work as structured and now the government is going to throw (another) $850 billion down the rat hole ($700B bailout + $150B in tax breaks and pork).

More alarming than the stock market's decline, credit spreads widened further with LIBOR - a key measure of bank-to-bank lending - hitting an all-time high Friday, Bloomberg reports.

"Unfortunately, we are one accident away from a systemic financial meltdown," says NYU economics professor Nouriel Roubini of RGE Monitor, whose predictions about this credit cycle have been scary - and frighteningly accurate. "It is a situation of generalized panic."

In a conference call Thursday evening, Roubini noted government interventions this year have been getting increasingly bigger - starting with the $29 billion for Bear Stearns-JPMorgan in March to $700 billion today - with increasingly diminished returns, as detailed here.

So what, if anything, can the government do at this point to restore investor confidence, which was the underlying point of this exercise?

Forget rate cuts, or even a bank holiday, as some are chattering about. Roubini says the government needs to take "much more radical" action:

Provide blanket FDIC insurance on all deposits, without limitations. This will stress the Fed's balance sheet but will stop a "silent run on the banking system" that's occurring because large institutions don't want exposure to any banks above the (new) $250,000 insurance cap, Roubini says. "[They] don't know who's next to go belly up and want to pull out."
Do "triage" on the banking system to separate those banks that are merely "distressed but solvent" and can survive with liquidity injections vs. those that should be shut down.
At this point it's pretty foolish to rule anything out, including the possibility of a crash. About the only thing to be optimistic about is that it's always darkest before the dawn and it's very dark right now.