Paulson's leaky bail-out
Paulson's plan will only buy time and it places too much burden on taxpayers instead of creditorsAvinash Persaud
guardian.co.uk, Wednesday October 01 2008 19:08 BST
It would have been a miracle for a politically divided Congress to come up with a well-judged package to save the US financial system in four days, amid a tight presidential election. We have an expensive plan that will not work. The $700bn plan will do little to avert an alarming meltdown of the US financial system that will spill over to the UK. The best that can be said is that the plan may buy some time to unveil another more durable plan – but this time has not been bought cheaply.
Like most regulatory initiatives, the Emergency Economic Stabilisation Act fights the last war, not the current one. Over the past 10 years we have had the "marketisation" of banking. Instead of taking deposits and providing loans, banks have been borrowing from
the money markets to buy highly rated, securitised packages, of seemingly diversified loans. When the subprime mortgage element within these securitised packages began non-performing in early 2007, it triggered a collapse of confidence in the entire packages.
On paper at least, banks had assets that more than covered their commitments to their creditors, but they were unable to liquidate these loan packages for cash when these commitments came due. The Federal Reserve stepped in by offering banks a temporary loan of cash and allowed them to post these troubled assets as collateral for the loans. Similar developments occurred in the UK after Northern Rock's collapse.
Banks hold capital to provide a buffer between the amount they owe creditors like depositors and bond holders and the value of their assets. Over the course of the last 18 months this capital has sunk to wafer-thin levels as banks have been forced to write down the value of their assets. These write downs have sometimes forced sales that drove prices down further. Today's problem is not a shortage of liquidity, but a shortage of capital. At current prices, banks are on the verge of insolvency. Paulson's plan does little to change that. ......(more)
The complete piece is at:
http://www.guardian.co.uk/commentisfree/cifamerica/2008/oct/01/marketturmoil.useconomy.bailout