The week that changed Wall Street forever
Philippine Daily Inquirer, Agence France-Presse
First Posted 08:15:00 09/22/2008
Filed Under: Economy, Business & Finance
WASHINGTON—Wall Street will never be the same after a week that saw the White House abandoning its laissez-faire attitude toward markets and organizing an unprecedented bailout of private companies.
The massive measures that the government has announced to restore stability to the US banking system could cost up to $1 trillion, including the proposed $700-billion rescue package for beleaguered financial firms.
To put that staggering price tag in perspective, the cost would amount to six months of economic output in a country like France.
But confronted with the worst financial crisis since the 1929 market crash that ushered in the Great Depression, did the Republican administration of President George W. Bush have any choice?
Days away from meltdown
In the middle of the week, the huge US banking system was on the brink of collapse: Its lifeblood—cash—no longer circulated; its pulse—measured by short-term interest rates—was spiking.
The morphine injected in massive doses—liquidity infusions by central banks—no longer had an effect.
An emergency operation was needed to remove the cancer at the heart of the global financial crisis.
The United States “may be days away from a complete meltdown of our financial system,” said Sen. Chris Doodd, the influential Democratic chair of the Senate banking committee.
Late Thursday, Treasury Secretary Henry Paulson announced the broad outlines of a landmark plan proposed to Congress in which the government would buy toxic assets from financial institutions accumulated during the US real-estate boom and which since had soured in the worst housing crisis in decades.
Socialist state
In other words, the federal government would become the biggest hedge fund on the planet. That would follow the government’s seizure of the ailing mortgage-finance titans Fannie Mae and Freddie Mac, and the nationalization of the largest US insurer, American International Group (AIG)—two extraordinary actions in a country where the state shareholder did not exist.
“Welcome to the USSRA—the United Socialist State Republic of America,” said economist Nouriel Roubini, a former advisor in Bill Clinton’s Democratic administration.
Paulson, a former Goldman Sachs president, said it was time to end piecemeal attempts at addressing the crisis and attack it at its roots. He said the Bush administration and congressional leaders would work all weekend to craft the necessary legislation.
Much had changed since the start of the week.
On Sunday, Sept. 14, senior officials responsible for the US economy still thought they had things under control.
After three days of frantic discussions, Paulson and Federal Reserve Chair Ben Bernanke held their ground and refused to bail out Lehman Brothers, which had been buffeted by savage attacks on its share price amid rumors it would collapse.
No ‘systemic risk’
Paulson and Bernanke argued that Lehman, the fourth-largest of the Wall Street investment banks, did not pose a “systemic” risk. In other words, its failure should not trigger a cascade of other bankruptcies in the international financial system.
On Monday, Sept. 15, Lehman filed for bankruptcy protection. Rather than face the same fate, its prestigious Wall Street rival Merrill Lynch hastily arranged a takeover by Bank of America. The Dow Jones industrial average lost 504 points (4.42 percent), one of its steepest one-day declines since the Sept. 11, 2001, terror attacks.
Insurer AIG, a component of the Dow’s 30 blue-chip index, saw its shares plunge that same day. A banking consortium, which was trying under pressure from US authorities to put together an enormous credit lifeline to help the giant firm get through its difficulties, took fright and gave up.
The Federal Reserve was forced to make an about-face and open an $85-billion line of credit to AIG, in exchange for 79.9 percent of its capital.
The reason: In addition to its traditional role of insurer, AIG had guaranteed hundreds of billions of dollars worth of financial products whose value had plunged. There is indeed a systemic risk, the Fed concluded.
Investors panic
By Wednesday, Sept. 17, equities investors panicked. They withdrew massive amounts of investments and put them into traditional safe havens.
Gold registered its sharpest dollar climb on record, a leap of $88.75, and the yield on US Treasury bonds fell practically to zero.
The country’s oldest money market fund—a type of investment considered very low risk—announced that it was no longer able to redeem investments at the value they were bought.
Turmoil raged on the global markets, threatening to swamp other financial institutions like Morgan Stanley and Washington Mutual. The British bank HBOS agreed to be swallowed up by its rival Lloyds TSB. And Moscow’s two stock exchanges, in the throes of a meltdown, were closed.
Crash seemed inevitable
A crash on Wall Street seemed inevitable on Thursday, Sept. 18. Rumors of a massive government rescue package being prepared, however, began to surface.
Confirmation of a US government plan sent global stock markets roaring higher, with Paris and London indexes posting record one-day gains of 9.27 percent and 8.84 percent, respectively.
But could squabbling by American lawmakers delay putting Paulson’s massive bailout into action?
“If it doesn’t pass, then heaven help us all,” Paulson was quoted as saying by The Wall Street Journal on Saturday.
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