The US Pot calls the thai kettle black
After the US Federal Reserve's unthinkable bailout for Wall Street investment banking firm Bear Stearns, it is now time for the US government to ponder an even more unthinkable bailout of the financial system.
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Published on March 28, 2008
The longer they wait, the bolder or more costly initiatives will be required.
I have just read a report from Merrill Lynch titled "Tough Times Call for Bolder Moves" (March 26), in which it implies that the US financial system is already bankrupt and needs a federal bailout. Like Japan in the early 1990s and Thailand in the pre-1997 crisis, the US is still in denial mode that it is facing a very deep financial crisis. This issue has not been taken up in the presidential campaign; candidates are acting as if there is no problem at all. But sooner rather than later, there will be finger-pointing in Washington DC, before the law-makers create legislation, accompanied by financial sector reform, to bail out the financial system.
The Fed, under Bernanke, has already thrown away the textbooks. It is now providing unlimited liquidity support to the financial institutions, banks or non-banks, to prevent a financial meltdown. This practice is unprecedented since the Great Depression. Bear Stearns is the first investment firm to go under. It is one of the most leveraged firms, with huge exposure to the sub-prime problems.
If the Fed had provided liquidity to Bear Stearns - which had been facing a run triggered by rumours and subsequent market loss of confidence - the Wall Street firm would not have agreed to be taken over by JP Morgan. Immediately, after the Bear Stearns take-over was announced, the Fed created a special credit facility for the primary dealers - which are non-banks - to help relieve the credit crunch for other Wall Street firms. This implies that the Fed exploited the precarious situation of Bear Stearns - which deserved to go under anyway - to send out a stern signal that the problem in the financial system is grave.
The Fed has not yet fired all its policy bullets. It is being thrown into exactly the same situation as that of the Bank of Thailand's Financial Institution Development Fund (FIDF). At the height of the 1997-1998 crisis, the FIDF provided liquidity to the cash-strapped finance companies and banks, which in exchange put up government bonds, promissory notes, and eventually their golf courses, paintings and buildings as collateral. In the end, the FIDF found itself in a big mess, with Bt1.6 trillion in bad loans. The cost of the financial restructuring amounted to more than 60 per cent of Thailand's gross domestic product.
The Fed has now, according to Merrill Lynch, pledged a staggering 60 per cent, or US$495 billion, of its balance sheet to banks and brokers/dealers. The Fed's mandate is to safeguard the banking system and manage the money supply. But now it has expanded its oversight to cover the brokers and primary dealers for fear that their collapse will bring down the US financial system as a whole.
"Last Thursday, we learned that primary dealers, via the new Primary Dealer Credit Facility (PDCF), borrowed $28.9 billion, which marks the largest weekly loan extended by the Fed outside the day after 9/11," said the Merrill Lynch report.
"Tallying up all of the liquidity provisions pledged by the Federal Reserve so far - US$28.9 billion in PDCF (and this is unlimited, so the number could soar much higher), US$30 billion in loans to JP Morgan Chase/Bear Stearns, US$100 billion in TAF auctions, US$100 billion in rolling 28-day repos, US$200 billion in the Term Securities Lending Facility (TSLF) and US$36 billion in foreign currency swap agreements - the figure comes to US$495 billion.
"This represents 60 per cent of the Fed's current US$831 billion in portfolio holdings, consisting of Treasury securities and outstanding loans."
Is the Fed going broke? It seems that is the case going forward. Without congressional intervention to bail out the bad loans, the US financial system and the real economy will be thrown into a recession like Japan in the early 1990s.
When Thailand faced the financial crisis in 1997, the US told Thailand not to bail out the failed banks because it would create a moral hazard. The central bank must not provide unlimited support to the weak banks and finance companies because the cost of the financial restructuring would bankrupt the country's fiscal position. Thailand must not delay the strengthening process of the banking standard. It must not protect the financial services sector from foreign participation.
Now the US is doing exactly the same thing that it told Thailand not to do 10 years ago.
thanong@nationgroup.com
Thanong Khanthong
The Nation |
