Stocks staged a partial recovery today following Monday's historic declines, with the Dow Jones Industrial Average rallying more than 480 points by the market's close. Optimism about the resurrection of a government financial system bailout plan and possible changes to accounting rules helped drive the rebound.
Concerns continued to grow, however, about the world's credit markets with news of a spike in the London Interbank Offered Rate, or LIBOR, the interest rate that banks charge to lend to one another.
The LIBOR increase means it will be more costly and challenging for businesses and consumers to borrow money. Interest rates on credit card debt and many adjustable-rate mortgages may also rise as a result of the increase.
"It just really highlights the complete and utter lack of faith and confidence in the banking system," said Liz Ann Sonders, the Senior Vice President and Chief Investment Strategist for Charles Schwab & Co. "If banks are unwilling to lend to each other they're most certainly not willing to lend to businesses or to us as consumers."
Proponents of a government bailout of the financial system have said that such a rescue plan -- which could allow the government to buy up banks' troubled assets -- could help ease the credit crisis. But that argument didn't stop the House of Representatives Monday from rejecting a $700 billion rescue plan.
With the prospects for the bailout now in limbo, exactly how bad will things get? It depends on who you ask.
The predictions on Wall Street are dire. Louis Alexander, the chief economist at Citigroup Inc., which on Monday announced it was buying the banking operations of Wachovia, said that even if a bailout bill is passed later this week, some damage has already been done.
"Each little bit of delay causes damage to the financial system that's hard to take back," Alexander said.
But others say the bill's initial rejection may pave the way for measures that would help struggling homeowners.
The House of Representatives' stunning defeat of the rescue plan, which was backed by leadership in Congress and the Bush administration, left some questioning whether a bailout package will come to fruition at all.
Nerves have been especially frayed at the New York Stock Exchange, where the Dow Jones Industrial Average dropped more than 770 points Monday, a record decline.
David Henderson of Raven Securities, an independent broker, worried that continued uncertainty about the bailout would fuel further declines.
"If they don't do anything, it'll be a scary moment down here," he said, "and when you scare people, they do irrational things, and when irrational things start happening, you know, you're liable to ... see things plunge one way or another."
Kenneth S. Rogoff, an economics professor at Harvard University and a former economist at both the International Monetary Fund and the Federal Reserve, said he believed some sort of deal would ultimately receive congressional approval.
"The nature of these huge deals is always that they seem like they aren't going to happen until they happen," Rogoff said. "I think the overwhelming likelihood is that they will still reach an agreement with some tweaks."
Bailout Delay: The Bad News?
Citigroup's Alexander said that if a new deal happens this week, it would cushion the blows recently dealt to the U.S. economy, including the collapse of the investment bank Lehman Brothers, the near-collapse of insurance AIG (which received an $85 billion loan from the government), and the conversion of Morgan Stanley and Goldman Sachs from investment firms into bank-holding companies.
But, he said, the delay of a bailout approval has already had some consequences. Besides the turmoil in the stock markets, Alexander said that consumer and business spending will likely continue to slow.
"Each new little bout of economic volatility, financial volatility, pushes people in the direction of being more cautious," he said.
If it takes even longer for a bailout plan to be approved -- say, until after the presidential election -- Alexander said that policymakers could turn to smaller-scale solutions. The Federal Reserve, he said, could cut interest rates once again and could also lend more money to financial institutions.
And, even without congressional approval, mortgage giants Fannie Mae and Freddie Mac -- which were taken over by the government earlier this year -- could buy off a limited array of troubled mortgage assets from banks.
But even with the advent of such alternative solutions, Alexander said, Americans could expect to see the economy to continue to deteriorate with a tightening of the credit market, making loans harder to get for individuals and businesses alike. That means lower consumer spending, more job losses and possibly more bank failures.
"I think it would be a good thing if Congress came back and passed" the bailout bill, he said.
Citigroup had previously released a statement in support of the bill, but a spokeswoman for the bank said that Alexander, as an economist, had formed his opinions independently of his employer.
Bailout Delay: The Good News?
Some homeowner advocates see promise amid the forecasts of doom and gloom.
"I think all we can hope for is this presents an opportunity for them to do more for homeowners," said Brenda Nuiz, the legislative director for the Association of Community Organizations for Reform Now, an advocacy group for low- and middle-income families.
Nuiz said that lawmakers now have the chance to include in the bill provisions that were conspicuously absent in the legislation defeated by the house on Monday -- measures to directly help homeowners.
"We're looking for real language with some real teeth," Nuiz said.
Specifically, Nuiz said that the bill should allow the government, as the new owner of troubled mortgages, to mandate that loan servicers, such as banks and other companies, modify home loans to increase the likelihood that struggling homeowners will avoid foreclosure.
The defeated bill included a provision that said the U.S. Treasury secretary could "encourage" servicers to prevent foreclosures by turning to programs like Hope Now, a White House-backed effort by the private sector to work out solutions between lenders and home loan borrowers.
According to a statement released by Hope Now in July, the program had helped some two million homeowners fend off foreclosure.
But Nuiz said that many of the solutions offered by the program come in the form of "work-outs" that don't actually lower the amount of money homeowners must pay to stay in their homes. And the loan modifications that do happen, she said, take a long time.
Generally, servicers just aren't doing enough to help homeowners, according to the State Working Group, a team of state attorneys general and state banking regulators.
One out of every five loan modifications made in the last year are now delinquent, the group said in a report issued Monday.
"This has raised some serious concerns for us that the modifications made in the last year are modification in name only," said Iowa Attorney General Tom Miller. "They may have changed the terms of the loan, but they have not necessarily offered payment relief to homeowners that are struggling to make their payments."
Nuiz said that the government could improve and streamline the loan modification process.
ACORN and homeowner advocates also support a measure that would allow bankruptcy court judges to modify home loans.
Intervention by judges, Nuiz said, could also help more homeowners avoid foreclosure. And, she said, the prospect of seeing loans cut by a bankruptcy judge could encourage more home lenders to perform more loan modifications.
The addition of homeowner assistance provisions, Nuiz said, could provide the bill with the support it needs to achieve congressional approval.
"We hope it's at least up for discussion," she said.
With reports from the Associated Press and ABC News' Scott Mayerowitz, Betsy Stark, Justine Schiro and Sharyn Alfonsi.