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The Wall Street Bailout:
A Crisis Far From Over |
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VSAPAC,
Singapore - 22 September 2008 - The 700bn bailout
plan for the country’s financial institutions to
curb turmoil on the financial markets would allow
the government to buy the non-performing assets of
any US institution for the next two years, raising
the legal ceiling on the national debt from $10.6
trillion to $11.3 trillion. The plan is aimed at
restoring confidence in the financial system by
allowing US institutions to transfer their bad debt
to the government. |
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The
issue now is to what extent the policy makers can
take further, decisive action to fundamentally and
comprehensively address the root cause of the
financial system’s stresses. The focus will be on
the effectiveness of the federal government’s plans
to implement a program to remove these illiquid
assets that are weighing down the financial
institutions and threatening the global economy. The
proposal to create a ¬government vehicle to take on
the toxic assets in the financial system is the core
of the strategy put forward by Hank Paulson and Ben
Bernanke to turn round the financial crisis. |
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A
government-sponsored vehicle can help deal with a
situation in which investors fear banks do not have
enough capital to cover credit losses and banks
cannot raise enough new capital from private sector
sources. The government entity can address this by
purchasing problem assets from banks, giving them
more capital to finance their portfolios of problem
assets, or both. There are still intriguingly
outstanding questions as to the type of assets the
government-backed entity accepts; including the
level of simplicity (or complexity) of the credit
securities to add onto the portfolio and at what
price. The investment horizon and the manner in
which the assets are to be disposed of and the
process of valuing the securities also need to be
addressed. |
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If the
government acquires assets at the going distressed
market price, the incentive for banks to participate
is limited and the transaction might leave them with
a ¬capital hole. If the government pays more than
current market prices, the taxpayer will appear to
be subsidising the banks. One way to get round this
is for the government to acquire assets at today’s
prices but offer banks a share of any upside. |
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The
political negotiations on the rescue plan, which
followed a week of unprecedented stress in global
financial markets, envisage the most extensive
peacetime expansion of the role of government in the
financial system since the Great Depression and
appeared to many to mark the end of an era of
Reaganite deregulation. In addition, the Bush
administration has announced a blanket guarantee on
all money market mutual funds, in an effort to
curtail a brewing crisis in the $3,500bn (€2,422bn)
sector. The Federal Reserve announced new plans to
support liquidity in the mutual fund sector. |
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Upon the
announcement last week, stock markets around the
world staged huge rallies as the US authorities
moved towards agreement on a programme of government
intervention that would put hundreds of billions of
dollars of taxpayers’ money at risk in an effort to
quell the credit crisis. Shanghai surged 9.5 per
cent, in the biggest daily gain for seven years, to
2,075.091. Hong Kong ’s Hang Seng gained 9.6 per
cent to 19,327.73, breaking a seven-day losing
streak. In London the FTSE 100 had its biggest daily
gain in its 24-year history, jumping 8.8 per cent,
while in New York the S&P 500 closed up 4.0 per
cent, having risen 4.3 per cent on Thursday. The
rallies in London and the US were partially fuelled
by bans on short-selling in financial stocks
announced on Thursday night. |
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