It takes going back to the childhood nursery rhyme to capture the events of the past week in the United States of America. It was a week that began with Congress voting down a US$700B rescue package on the first working day of the week followed swiftly by the largest one day stock market decline (in points term but not in percentage terms), a high level, high voltage CPR carried out by the United States Senate on Wednesday and a volte-face by Congress two days later. And this is no hyperbole – no less than the US Chamber of Commerce, which represents business leaders, said: “With the American economy on life support, Congress took the necessary step to stop the bleeding.”
Even the lame-duck President George Bush took time off from his laid-back schedule, appealed to the American people who by an overwhelming majority think he is doing a bad job but who used all the powers of the “most powerful man on the planet” to sway the votes of Congress that a few days earlier had voted on the basis of instructions from back home. Conventional wisdom after all was that it was mainly Wall Street’s greed that causes the problem in the first place so why should they be bailed out. By the end of the week however, no longer was the sky falling down considered the mere fantasy of Chicken Licken; everyone suddenly realized that things were worse than predicted and getting worse. In fact President Bush’s description that the situation was extraordinary was considered an understatement as credit dried up, banks balked at lending to each other and the job numbers nose-dived. Timing is everything and the coincidental release of employment data showing that some 159,000 jobs were lost in September, the worst in five years, was enough to make even a Congressman/woman ignore the advice of their constituents and to change their minds. For them just getting through 2008 without any further shocks would be not only a release but an achievement.
Poisoned chalice
The reversal of 58 no votes on Monday prodded by the Senate’s overwhelming support for a modified package was enough to see the bill’s passage in the Congress by a comfortable margin of 263-171.
Bush did not hesitate and within two hours he had put his signature on the largest financial rescue package since the Great Depression some eighty years ago. Welcomed by politicians including the two Presidential contenders vying for the most poisoned chalice in the world, the law failed to impress the US stock market which ended down 157 points after being up by more than 300 points before the voting began,. At 10325.38, the decline capped the worst week for the Dow Jones Industrial Average in more than six years, and left the market trading where it was nearly three years ago.
Notwithstanding these realities some commentators actually wondered aloud whether the passage marked the best of Washington – bipartisan agreement made in the interest of the country rather than in the interest of the voters back home. In fact the bill would probably not have passed without some genuine improvements such as a 150% increase in the guaranteed amount of bank deposit from $100,000 to $250,000 per depositor. The bill which grew from a three page document by Treasury Secretary Henry Paulson to some 450 pages also includes a tax provision, which will shield more than 20 million middle-income households from the alternative minimum tax.
But keeping with Washington’s tradition of pork-barrel politics, support was also bought at a heavy price. The sweeteners will amount to some US$150 B and include a 39 cent tax break for an Oregon company that makes children’s wooden arrows, tax breaks for commuting cyclists and provisions to help film and television production companies as well as renewable energy firms. Of course these will simply increase the huge deficit and debt of the US government. Bush seems willing to pass that problem to the next administration which will be headed by someone whose knowledge of economic matters is at best rudimentary. To meet one of Barack Obama’s conditions for support is the hugely popular limit on pay to senior banking executives.
Profit or loss
The rescue can result in several financial institutions making profits on the toxic loans they off-load under the bill if the price they receive is higher than the book value of the loan. In any case having liquidated those loans they can now switch the funds to other income earning loans and investments, resulting in higher profits. There is doubt in some circles as to how much the rescue will cost, if it will cost at all. Some see the government as actually making a profit on the loans − depending on the price at which the mortgages are taken over and the influence of politics on how strictly repayment conditions are enforced. There is also some doubt on whether the real outlay is the $700B we have been hearing about. The treasury has admitted to some arbitrariness in the figure of $700B while the respected Forbes magazine has quoted a treasury spokeswoman saying that it was not based on any particular data point: “We just wanted to choose a really large number.” Sounds like the equivalent of shock and awe made famous by Vice President Cheney and Donald Rumsfeld.
The bill takes a slightly more cautious approach. It allows Mr Paulson to spend $350B immediately buying up the mortgage-related assets from the stricken US financial sector and another $350B with the approval of Congress. But this is unlikely to take place immediately as the institutional arrangements have to be made, people recruited, pricing mechanisms agreed and transactions concluded. If the Treasury pays too much for the assets it can lose big-time while if it pays too little the whole objective of the scheme will be defeated.
Ideally this can take several weeks but time is surely a luxury which they cannot afford.
What next?
Despite the cold reception of the market to the bill, everyone agreed that to do nothing in the circumstances was simply not an option, that haemorrhaging would exacerbate and the collapse of the largest economy would no longer be a matter of if but when. While there are many who take satisfaction in the pain and humiliation of the US, it is still the world’s largest economy, largest buyer of goods and services, borrower, contributor to the United Nations and the country from which the developing world including Guyana receives its largest remittances. It is in no one’s interest for the US economy to collapse.
A weak US economy poses a real threat to the rest of the world. Therefore anything that prevents a catastrophe in the US will help the rest of the world, which after all is now interconnected not only by the internet, but by globalisation of which banking is perhaps the most integrated example. Not only will the package allow the US to fix some of the fundamental problems of the economy, but it should help to restore confidence to the markets and give a short-term fillip to stock markets around the world while allowing banks to carry out one of their most essential and routine functions – lending to each other.
But the problem is as much a structural one as it was a cash flow question. Bigger and more fundamental changes are necessary not only in the US but abroad as well. It is naive to think that the mortgage and financial crisis is a peculiarly American thing. The US’s soul brother, the UK has its own crisis. Having nationalised and guaranteed the deposits of the bank Northern Rock and the mortgage company Bradford and Bingley, the state now has a combined burden of public sector debt and exposure to the housing market resting on the shoulders of the UK taxpayer to almost £1 trillion. In all of this small countries have little say, although we in Guyana cannot be unmindful of the real danger to us as a commodity producer in a world economy which according to the UN Conference on Trade and Development (UNCTAD) is teetering on the brink of recession. A world financial system that seems to falter fundamentally almost with the predictability of the holding of the Olympics must be fundamentally flawed. Not too long ago it was the Asian crisis and then there was the near collapse in Mexico to which President Clinton lent a helping hand. It is perhaps a measure of the size of the US economy or those of the rest of the world that there is no one willing or able to lend to America a helping hand.