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WASHINGTON hopes its sweeping bailout plan will get credit flowing again. But will it work on Wall Street? That is the US$700-billion ($1-trillion) question swirling around the biggest bailout in history. The first answer will come from the credit markets, where this crisis has unfolded for more than a year now.

Few economists see the rescue as a quick fix. Even if the frozen credit markets thaw a bit - and many analysts say they will - the good old days of easy money are over for now. The United States stock market, which has lost about 17 per cent this year, is bound to remain volatile. To many, a recession seems unavoidable.

The first big question, however, is whether some semblance of calm will return to the credit markets. If the plan works as hoped, market interest rates that have been stuck at unusually high levels should start to ease.

If that happens, banks and corporations would be able to borrow money at lower rates than they have in recent weeks, said Mr Mark Zandi, chief economist and founder of Moody’s Economy.com.

Since Lehman Brothers sank into bankruptcy, rates on short-term corporate borrowing have shot up. Investors have shunned all but the safest of investments, like US Treasury bills and notes. Last week, prices of two-year Treasury notes rose for a fifth straight week, a run that has reduced their yield by about a third of a percentage point.

“The most important thing is to see money markets normalise,” said Mr Zandi, who has advised the presidential campaign of Republican Senator John McCain. “If banks start lending to each other that would be a very positive sign and that would be key.”

Many borrowers are being penalised in the bond markets, if they can borrow money at all. Credit spreads - the premium investors demand to lend money to everybody but the federal government - need to fall, said Mr Jerry Webman, chief economist and senior investment officer for Oppenheimer Funds. Last week, in a rare reversal that occurs only in times of extreme stress in the credit markets, tax-free municipal bonds were yielding more than Treasuries, which are not tax exempt.

“Credit is man’s confidence in man,” Mr Webman said. “That confidence in the financial system needs to increase.”

Analysts said the market would be watching closely how the Treasury Department structured its planned purchases of troubled assets from financial firms. The government has suggested it might use auctions to establish prices for the securities and loans it plans to acquire.

Once investors have a better sense of what the troubled assets are worth, they will become more willing to invest in ailing financial firms that have not been able to raise capital because analysts fear they have not fully disclosed the quality of their assets.

Furthermore, once financial firms have raised more capital, a crucial test will be whether they plough that new money back into the market through loans and investments in businesses, said Mr Webman. If banks remain fearful and hoard cash instead, as they have done in recent months, the rescue effort will only have a modest impact on the economy and financial system.

But even if the government intervention is successful, economists and investors said it would not restore the days of easy credit that prevailed during the recent housing boom.

Furthermore, the rescue might not forestall a recession, said Mr David MacEwen, chief investment officer for the bond department at American Century Investments. Though he thinks the rescue efforts will help the economy, Mr MacEwen expects bankruptcies to spread, US home prices to fall and unemployment to rise.

“Having this plan contains the damage to some extent,” Mr MacEwen said. But, he added: “I think we are going to see slowing in economic activity. This is like steering a battleship, you make course adjustments but they take time to take effect.”

Source : Today - 30 Sept 2008