EXPRESS CHECKOUT

Fear and finance

Posted in Business + Economy, Law + Social Policy, Mass Communication, Politics + Diplomacy by expresscheckout on 30 September, 2008

Why bailouts only add to the sense of panic
By Sean O’Grady
September 30, 2008
The Independent

In the eternal battle between fear and greed that drives the financial markets, it is not difficult to see who is winning. But why the fear? Why, when governments are almost falling over themselves to douse the fire in the markets with the soothing balm of billions of taxpayers’ dollars, euros and pounds? Why, when Gordon Brown says that he will do “whatever it takes”? Why, when President Bush pledges that “We’ll make clear that the United States is serious about restoring confidence and stability in our financial system”? And why – when almost every depositor in the developed world has received an implicit or explicit state guarantee that their money is safe – do we fear yet more runs on the banks?

One answer has obviously been worries about the prospects for the Paulson plan itself – whether it would be passed by Congress and, if passed, whether it would actually work. More broadly, traders and investors also know the price that those governments and taxpayers around the world will have to pay for the Paulson plan and its counterparts. There is reason to look on the bright side. It may well prove, in the case of the United States, for example, that any taxpayer losses on the $700bn needed to relieve the banking system of its toxic assets will eventually prove slight. Optimists point to the two major historical precedents to make their point. They claim that both the scheme President Franklin Roosevelt ran in the New Deal in the 1930s (an even bigger $1.2 trillion affair at today’s prices), and the 1990s bailout of the US’s bust Savings and Loans institutions (running to a comparatively modest $125bn), both returned small profits in the end.

In the same way, on this side of the Atlantic voices of calm point out the extreme unlikelihood that even a substantial minority of Bradford & Bingley mortgages will go sour. The vast majority of these home loans, if the Treasury holds them to maturity, will be paid off, in full, with interest. Given the Treasury’s ability to fund its activities more easily than the banks, it might even turn a small profit, especially if the housing market doesn’t tank quite as badly as some fear. The Chinese, the Singaporeans, the Gulf states, the Russians even, it is said, will be happy to buy more US Treasury bonds, British gilts and European government securities. Yet the fears are much more potent. For the worry is that governments in America and Europe will struggle under the burden of all that debt. Their taxpayers, already hard pressed, will be squeezed still more. The debt has to be serviced. On top of our vast personal debts we are now adding a further layer of public-sector debts. It will mean even less consumer spending and even lower growth, and perhaps more prolonged and deeper recessions.

The second worry follows from that: the confidence the rest of the world reposes in the dollar. Could the dollar itself be the subject of a run? Some sovereign wealth funds, the quasi-official bodies who invest the trillions earned from exports by China and the other coming world economic superpowers, are upset that they have lost billions on the money they ploughed into buying shares in Western banks. They seem unwilling to stump up for more, and may even start to “diversify” out of the dollar. The consequences of China unloading its trillions of holdings of US government debt are unpredictable in detail but certainly devastating to the US and the world economy. The US and China, the planet’s biggest debtor and creditor respectively, are leaning on each other like two drunken giants. That may not be a sustainable arrangement. In its own small mini-me way, sterling too could see a further collapse in international value.

Nor can the world “draw a line” under events with the latest round of nationalisation and rescue plans, any more than it could with their predecessors. The recession will see to it that the property armlets continue falling, unemployment will rise, and arrears and defaults blow more holes in the balance sheets of the banks. And when that happens they have little option but to restrict their lending still more, pushing the economy into a vicious cycle of decline. What is plain is that no amount of taxpayer money, no vote in Congress or the Commons and no speech by a president or prime minister can now fully restore the confidence that has been drained from the system during a year of brutal capitalist “creative destruction”. Confidence is the magical ingredient that makes our system work, the thing that allows Keynes’ “animal spirits” to take off, and create businesses and wealth. And, as we have seen from the billions wiped from the stock markets yesterday, it is simply beyond price. Without it, there is merely fear.

See also: ‘Bush warns over bail-out delay’ (BBC News)

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