Lessons of US financial crisis

Developments over the past fortnight are proving that the financial troubles originally brought on by the United States' sub-prime housing loan crisis, are worse than all but the most pessimistic were predicting when it first began making headlines about 18 months ago.

Last week Washington outlaid a huge expenditure for bailing out government-sponsored mortgage lenders Fannie Mae and Freddie Mac. Monday's tumble of the New York Stock Exchange of over 500 points on the heels of news that one of America's largest investment banks - Lehman Brothers - was declaring bankruptcy, and another, Merrill Lynch, was being sold to Bank of America, made it the worst day since Sept 16, 2001, the first day the NYSE opened for business after the World Trade Center attacks. All in all, it was estimated that about $700 billion in real value had been lost by market investors. The losses continued into yesterday, when the Federal Reserve Board was scheduled to meet to discuss strategies to staunch the bleeding.

Certainly in this age of globalisation the damage will not be confined to the United States. Trading yesterday was sharply down in all Asian financial market.

Former head of the US Federal Reserve, Alan Greenspan, said on Sunday that the US was now in a "once-in-a century" financial crisis, the worst he had seen in his career, and likely still had a long way to go. Eighteen months ago, Mr Greenspan was predicting that the US economy would weather the storm without a major fallout.

The US government has been playing with interest rates and applying tax revenues judiciously to try to avoid what many are now admitting is a real danger of financial collapse. What is most discouraging is that in these 18 months there has been very little done to address the real cause of this mess - the deregulation or lack of regulation of new sectors of the banking industry.

The term "sub-prime" literally means less than optimal, but many of the practices embraced by mortgage loan firms were just plain irresponsible. These included "balloon mortgages", where the borrower pays only interest on the loan for 10 years, at which time an accumulated payment comes due; and "liar loans", where the borrower is not required to submit documentation to verify reported income; and other devices to qualify just about anyone and everyone for a home mortgage loan.

These lending practices played a large role in the US housing industry boom, now just a memory, and played a large role in keeping the US economy in a growth phase. As more and more people came to the end of their "grace periods", the predictable wave of defaults and foreclosures gathered strength and took their toll on the economies of the US and the world.

Economist and New York Times columnist Paul Krugman was one of the first to sound the alarm about the situation. And in a column printed in the NYT on Monday, he warned about what has been described as a shadow banking system that goes far beyond just the housing mortgage sector and which has escaped the scrutiny of the federal government.

One reason for the lack of regulation is that few lawmakers have the sort of understanding Mr Krugman does for the very complicated issues involved. Another is that historically - as in Enron, the 1980s Savings and Loan scandal, etc - those who make their fortunes by playing loose with the rules are rarely the ones to bear the brunt of the economic hard times that follow.
Courtesy: bangkokpost