The global stock markets tumbled, starting Monday week with Lehman Brothers filing for bankruptcy after acquisition talks with the Bank of America fell through. By Tuesday Barclays agreed to pay 1.75 billion dollars for some of Lehman Brothers' prime US assets which include mostly Lehman's New York headquarters and two data centres.
Lehman Brothers had total trading assets estimated at 72 billion dollars and 68 billion dollars in liabilities. The two will be merged as Barclays Capital and may assist in arresting the outflow of customers in the aftermath of the largest bankruptcy in US history.
Why did the US government decide not to bail out Lehman Brothers, when nine days previously it had nationalised Freddie Mac and Fannie Mae? The decision represented a selective approach by the Bush administration towards which financial giant to bail-out and which one to leave to the wolves.
Perhaps the selectivity may be an indication of the rationale employed by Paulson, the Treasury Secretary, who had admitted after the nationalisation of Freddie Mac and Fannie Mae that, "the ultimate cost to the tax payer will depend on the business results...going forward." Or, in other words, the cost to the tax payers would be dependent on the ability of the government to eventually either turn the companies around or to sell them off piecemeal in order to recover the cost of the bail-out package. No one, of course, is under any delusions: the actual sale of these companies is not likely to generate the amount of the bail-out package.
The markets reacted sharply to Lehman's filing for bankruptcy. From Wall Street to London's FTSE to Japan's Nikkei to France's CAC to even the rich Arab countries like Saudi Arabia and Kuwait and Abu Dhabi all witnessed a crumbling of their stock markets.
A day later the American policy makers, in what was considered as a clear volte face in policy, decided to bail-out American International Group (AIG), the largest insurance company in the world and granted an 85 billion dollar revolver loan for two years with a yield of three months Libor plus 8.5 percent.
AIG will now attempt to sell assets in order to repay the loan from the Federal Reserve Board (Fed), which is intended as a bridging loan. The New York Times writes that what frightened Fed and Treasury officials into this action was not yet another big bankruptcy, but AIG's role as a considerable provider of financial insurance contracts to investors who bought complex debt securities. They effectively required AIG to cover losses suffered by the buyers in the event the securities defaulted. It meant AIG was potentially on the hook for billions of dollars' worth of risky securities that were once considered safe. However the bail-out was not sufficient to calm global markets. More was clearly required.
And thence began the preparation of a massive bail-out package which envisages mopping up all the banks' toxic mortgage debts. It is estimated that this would cost the tax payers around 1.5 trillion dollars - money which the US does not have. The option: bond issuance with obvious implications for the rate of inflation. The bail-out package itself was presented to Congress on Friday and Congress assured the government that it would act on it as quickly as possible to avoid a financial meltdown.
The package is expected to be approved today or tomorrow however the expectation of the package calmed down markets immediately and the gains by Friday had wiped out all the earlier losses during the week. Or, in other words the government succeeded in changing the perception of the investors - the primary objective of the package.
Not fair, proclaimed the US general public angered by reports of the bail-out package from their tax money. Why is tax money being used to bail-out rich companies who were inefficient? Cheap money, so argue many an analyst, had benefited the average Joe as well. While there is clearly a need to monitor and regulate the financial markets now, a change in stance that is now acceptable to even die-hard right wing neo-conservatives, yet before the bubble burst everyone was having the good life.
It is no wonder that there is bipartisan agreement in Congress that the bail-out package is a difficult one to endorse. Republican Tom Davis put it succinctly: "We are between a rock and a hard place at this point. No matter what you do it's controversial." Senator Van Hollen stated, "We need to look at the whole area of executive compensation and find a way to end this outrageous practice of CEOs who engage in grossly negligent activity and then end up with soft landings because of their golden parachutes.
Republican Senator John W. Warner said the executive and legislative branches need to decide "what is the risk of doing nothing, and letting the free marketplace do its role, or seek legislation to reduce the severity of serious consequences to almost every single aspect of our economy." Senator Hoyer said that in hammering out the rescue package, "our priority will be to protect taxpayers on Main Street, not reward bad decisions made on Wall Street."
Rep. Donna F. Edwards looked to the future, "The system has been so deregulated that nobody was watching the store. This can never be allowed to happen again. This can't just be about taking care of Wall Street and not taking care of Main Street. We have people who are losing their jobs and their homes, and I want to make sure that whatever package we come up with next week clearly should stabilise our financial markets but also do something to stimulate this economy, so people are put back to work and they're not losing their homes."
At the same time central banks of all major countries of the world are pumping billions of dollars into the system to stem the perception that a credit crunch is sure to follow. During the 13-14 September weekend alone central banks pumped around 300 billion dollars into the system. Last week the Fed and five other central banks, namely, European Central Bank, the Swiss National Bank, the Bank of Japan, Bank of England and Bank of Canada agreed to pump an additional 180 billion dollars into the global financial system.
So would this mark the end of the crisis and no more major financial institutions will be up for sale or filing for bankruptcy? Perceptions are fragile and can change at a moment's notice but for now they appear to be in the positive quadrant. However, there is unanimity in the view that the government needs to change the way the financial sector operates.
Pakistan so far has remained immune from the negative effects of the global financial crisis mainly because the August floor for the market's benchmark will insulate the market from being affected. Be that as it may, there is little doubt that capital market foreign fund participation has declined in Pakistan. Analysts fear that the small number of key market players in our stock markets may insist that the government undertake a similar bail-out package. This is not possible given the state of the Pakistan economy. Some may argue that the US debt situation is and would be much worse than Pakistan's after the bail-out package yet this comparison presupposes that the capacity of the two economies to sustain budgetary deficits is similar. This is simply not the case. The US capacity is almost legendary.
The creative debt instruments responsible for the bubble in the global markets are not available in the Pakistani market. Thus while reform is critical for the long term in the US market, reform of our capital markets has to take a more basic turn as is evidenced from ongoing donor support for our capital reforms.
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