In the 1930s, the US Congress did more than its fair share in helping to turn a financial crisis into a global depression. Yesterday it looked as though it was auditioning to assume that role again.Back then, Congress’s vote for protectionist legislation, the infamous Smoot-Hawley Tariff Act, which erected trade walls around America, almost brought to a halt the free movement of goods and services vital to the efficient functioning of the global economy.
Yesterday, in rejecting a plan to help to rescue the US financial system that had been constructed and reconstructed by the Bush Administration in collaboration with the Democratic and Republican leaderships, the House of Representatives dealt a hammer-blow to an already almost immobilised global financial system.
In the immediate aftermath of the vote, Washington and Wall Street were plunged into chaos. The initial House vote to reject the so-called Paulson plan was by 226 votes to 206, though the Democratic leadership scrambled to try to pull more opponents of the vote across to pass it. But as time appeared to be running out, financial markets went into a state of shock, with the Dow Jones Industrial Average plunging to 778 points. The broader S&P index recorded its largest one-day percentage fall since the crash of 1987.
Even worse hit were the credit markets. For weeks now, banks have been so concerned about the creditworthiness of their counterparties that they have been unwilling to lend for anything other than very short periods. That has sent interest rates on loans to companies and other private sector institutions skyrocketing, and that trend intensified last night.
The fear stalking the markets is that Congress might in effect have been saying that there was no more money coming to the aid of beleaguered banks and that they would have to deal with the consequences.
Late in the day in Washington, as they digested both the shock of the vote and the repercussions in markets, officials from the Administration and Congress were again at work trying to find a way to make the Bill more palatable to its opponents. The problem was that opposition came from both sides of the political divide. A sizeable number of Democrats opposed the plan because they objected to what they saw as a bailout of the comfortable and well-upholstered banks of Wall Street; a larger number of Republicans were against because they opposed substantial government support for just about anybody.
The implications for the global economy could be profound. Administration officials have argued (sotto voce, for obvious reasons) that if there is no bailout, more financial institutions are at risk of collapse.
Yesterday the global crisis had already entered a new phase, as governments moved to take control of vast swaths of the financial system. In Britain, Bradford & Bingley joined Northern Rock as a ward of the Government. In Europe, the banking operations of the insurance company Fortis were taken over by the Dutch and Belgian governments. Iceland moved to nationalise the bulk of Glitnir, one of the country’s largest banks. If the US financial system, the focus of most of the underlying problems in the economy, cannot get rid of the trillion dollars or more of bad assets on its books, the chances are that there will be much more intervention by the Federal Reserve, the Bank of England and European authorities.
The biggest danger is that the higher interest rates now shooting through markets will squeeze consumers and companies harder everywhere.
Yesterday the Federal Reserve injected a new round of financing into the system to try to free up the immobilised markets, lending unprecedented sums of money to US and European banks to help them through the crisis.
There have been worrying signs in the United States that the financial crisis is starting to unsettle bank customers. Sketchy data suggests that people are moving deposits out of banks that are considered more at risk than others. This has not yet turned into a full-scale bank run, but any more uncertainty could change that.
In any case, as the financial condition of some banks weakens, their ability to lend, already severely constrained, will be crimped further. In the ultimate nightmare scenario, the seizing-up of the global financial system will drain the lifeblood from the global economy and a world recession much deeper than anything seen in the past 50 years would be inevitable.
But is this view, expressed yesterday in panicky financial markets, really justified? In fairness to the opponents of the bailout, the plan was certainly flawed, even after it had been recast in the past week. Critics say that the financial markets would not have been improved significantly by the Bill even if it had been passed by Congress.
They say that the Administration and Wall Street are responsible for the atmosphere of alarm yesterday because they told the world that this plan was absolutely essential to avoid a disaster. The spectacle of Hank Paulson going down on his knees last week in a semi-jocular plea to Nancy Pelosi, the Speaker of the House, may have been good theatre, but it created the wrong impression, critics say, and raised unreasonable public and market expectations about how crucial this legislation really was.
They insisted that the failure of the Bill yesterday presented an opportunity to start again and construct a less flawed version of an economic support plan that might represent less of a blank cheque for financial institutions that got themselves into this mess.
Others were suggesting that the US should steer away from signalling that it would bail out its financial system at all. There is even a view among some conservative economists that, in the end, faith in markets will be justified and that Wall Street, for all its howls of anguish, will find a way to resolve this crisis more efficiently than through Government intervention.
The next day or so will be critical and it will be the financial reaction around the world that will determine what happens. If the worst fears are realised and markets fall into a complete funk, or if signs begin to proliferate of a run on deposits in some of the weaker institutions, the pressure on the dozen or so members of the House needed to pass the Bill will surely mount. Paradoxically, if financial markets around the world stabilise in the next 24 hours, as unlikely as that seems, the mood in Congress might harden against a bailout.
The underlying conditions in financial markets certainly do not suggest that calm is about to return any time soon. Things look decidedly perilous. The plan rejected by Congress yesterday may not have been a perfect measure, but something needs to be done. It is still not too late to save the system. Yesterday, not for the first time, the US Congress took a fateful step towards driving the world over the cliff.
Source :Timesonline
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