Wed, Oct 01, 2008 - Page 8 News List

Wall Street gambled, everybody lost

By Tao Yi-Feng 陶儀芬

Last week, Lehman Brothers, Merrill Lynch and American International Group (AIG) ran into severe problems paying off their debts, which pushed Lehman Brothers into bankruptcy, compelled Merrill Lynch to sell itself on the cheap, and led to a takeover of AIG by the US government. It was the tensest week in financial markets since the start of the subprime mortgage crisis last year.

The US Treasury Department and the Federal Reserve Board came up with an emergency plan to the tune of US$700 billion. The plan was sent to Congress, with a request for urgent legislation authorizing the Treasury to purchase toxic mortgage-related assets from financial institutions on Wall Street.

This was one of the biggest instances of government market intervention in history. Prior to this, it would have been inconceivable for the US, a country that strongly believes that individuals are responsible for their own misfortunes, to go to such lengths.

Even more ironic was the fact that it was Wall Street — perhaps the strongest believer in laissez-faire market economics and Darwinian finances — that was unable to take responsibility for its own actions.

Over the past 30 years, these “fittest” market economists have used their strong political influence to push other countries toward laissez-faire market economics, calling on governments to loosen financial restrictions and in the process opening up more economies to severe competition on the heels of rapid international capital flows — all in the name of efficiency.

However, after the ongoing financial crisis reared its ugly head, we were shown that loosening financial restrictions does not actually improve transparency in market information, nor does it allow for the most effective allocation of resources.

The only thing the loosening of restrictions accomplished was to allow financial institutions on Wall Street to play their money games. And the more they gambled, the greater their appetite became for risk and profit-taking.

In the past, the destructive behavior of these gamblers had a negative influence on the economies of other countries, but things have now swung around and their actions are starting to hurt the US economy.

The US$700 billion debt issue is equal to what the US has spent on its war in Iraq. In simpler terms, it is the same as asking every US citizen to pay US$2,000 to help clean up the mess created by Wall Street investors.

The US government’s plan is clearly aimed at “taking from the poor and giving to the rich,” but everybody has been discouraged from saying anything against it, for opposing something that could potentially help stabilize the market is bound to attract opprobrium.

The plan sought to convince the market that the Treasury Department will take on the bad assets of the main US financial institutions to help them regain the confidence of investors while escaping the vicious cycle that has gripped house prices and the financial market since the suprime mortgage crisis began.

Judging from stock market reactions around the world, the plan seemed to have restored some confidence — until the US House of Representatives defeated the plan on Monday, to which global markets reacted negatively.

For Treasury Secretary Henry Paulson, this is a challenge he cannot afford to miss. If a revised plan — and we can expect one will be proposed — succeeds, the US financial market will avert disaster and the economy will avoid recession. The quicker the housing market and prices stabilize, the quicker the bad assets taken over by the state can be sold off at a better price, thereby lowering US government debt.

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