"Likely to Get Worse before It Gets Better"

David Wessel on the current state of financial markets and the economy:

The Worst May Be Over, but..., by David Wessel, WSJ: ...Here's where the story stands right now: Barring any unanticipated collapse of a pillar of Wall Street or a European bank, the risk of financial catastrophe has receded, even though markets remain so far from normal that they're exceptionally hard to read. But the wave of economic pain -- the foreclosures, bankruptcies, pay cuts and layoffs -- has yet to crest. ...

Yet some key measures suggest things are moving in the right direction. In markets where speculators can bet on the collapse of a big bank or company, the odds placed on a big bank going bust have fallen... The odds the markets put on a wave of defaults by nonfinancial corporations also are down. And yields on short-term U.S. Treasury bills, which plunged as money rushed into the ultimate in safe securities, have inched up...

The Fed's aggressive actions -- cutting short-term rates ... and devising new ways to lubricate money markets -- have helped. Equally important is the ability and willingness of big financial companies -- Citigroup, Wachovia, Washington Mutual and (if they keep their promises to regulators) mortgage giants Fannie Mae and Freddie Mac -- to raise billions of dollars to rebuild their diminished capital cushions. This capital-raising is essential if banks are to keep lending... It's also a hopeful hint that some big-money players think it's time to invest in U.S. banks, albeit at bargain-basement prices.

But all is not yet well. Persistent strains in the market where banks lend to one another overnight, or for just a few days, are baffling... Banks understandably continue to be cautious about making mortgages and other loans... But cautious about lending to other banks? That's unnerving to say the least. ...

What about the rest of the economy? Employment is falling. So are housing prices. The bulk of forecasters in the latest Wall Street Journal survey foresee home prices declining into 2009; nearly one in eight say they won't touch bottom until 2010.

Prices of food and energy are rising. And a credit crunch is sure to make it tougher than usual for American consumers to borrow to keep spending. ...

Offsetting that drag on the economy is the vigor of U.S. exports. And, of course, the impact of the interest-rate cuts the Fed already has made and the checks Mr. Bush and Congress decided to send to most American families this spring has yet to be fully felt. ...

Nevertheless, the economy where most Americans live and work -- that is, off Wall Street -- looks likely to get worse before it gets better. ...

I can't resist adding this Mike Luckovich cartoon (from The Big Picture):