Global Trends by Martin Khor
Monday 6 October 2008
After high drama,
Last Thursday the
US$700 billion bailout plan was finally approved by the
This was after much drama. The bill was originally rejected by the House because of intense pressure from the public who are outraged that the banking “fat cats” are being bailed out by tax payers while house buyers are not and many are losing their homes through mortgage defaults.
After a minor touch
up, both the Senate and the House passed the bill, because they were
told that the
Despite the adoption
Firstly, more data
showed the “real economy” is sinking. The loss of jobs hit a five-year
high in the
Secondly, the prices
of oil and many commodities have fallen sharply, due to speculative
forces and the fall in demand, heralding the end of the commodities
boom. Developing countries like
Thirdly, while most
media attention was on the
have had to rescue six banks, some of them household names, such as
Bradford & Bingley (of the U.K.), Fortis (the Dutch-Belgian bank
which owns parts of
Several other banks
are in a precarious situation. But unlike the
A finance-crisis summit of four major European countries ended last Saturday with only pledges to cooperate, but no concrete plan.
On the ground, depositors
have become jittery. They are “fleeing to safety” in the
And when the Irish government announced it is guaranteeing deposits in its six domestic banks, this caused a storm in other countries, as people are shifting their funds to Irish banks, at the expense of other banks.
Fourthly, the “credit crunch” has really worsened, in that banks and companies are now largely unable to get loans from the money markets. This in turn means that the banks are reducing loans to consumers and businesses (thus worsening the recession) while companies could face financial problems as well as cut their investments.
The credit crunch is taking place in various financial markets. The “money market”, in which banks lend to one another, has been largely frozen as the banks fear that other banks may be having problems.
As a result, the cost of borrowing has shot up to record levels. Although the central banks have pumped hundreds of billions of euros of loans to banks to make up for the scarcity in the money market, many banks are still short of funds.
The inability to
borrow funds has contributed to the insolvency of the banks that had
to be rescued. We can expect more banks going under in
Then there are the “money market funds,” which provide short-term loans known as “commercial paper” to companies. There is now a virtual freeze in this market, with even top companies like General Electric and AT&T unable to tap it. In three weeks, US$200 billion was taken out of CP, a type of short-term debt, and last week alone the amount lent to companies fell US$95 billion.
A market strategist was quoted by Financial Times as saying that there is no area in the credit markets or banking system where companies are raising money, an “unbelievable” situation. This is problematic as the commercial paper market is where companies go to raise working capital to produce goods and services.
Fifthly, more problems are on the near horizon. For example, the US$54,000 billion credit derivatives market is facing a big test this month as contracts of defaulted derivatives on failed companies like Fannie Mae, Freddie Mac and Lehman Brothers are due for settlement.
This could result in billions of dollars of losses for insurance companies and banks that offered credit insurance, according to the Financial Times.
For example, Lehman’s bonds have been trading at 15 to 19 cents on the dollar. Thus investors who gave out protection (insuring that Lehman would not default) will have to pay out 81 to 85 cents on the dollar.
The credit derivatives market is not only huge in value but also complex in inter-relationships between institutions and counter-parties. A problem there could have wide repercussions.
Finally, the crisis
has so far been focused on the developed countries, but some developing