The US Financial Meltdown

It has been reported that over $5 trillion in total market capitalization has been wiped out since October of last year. Over a trillion of this amount was caused by the exposé of New York’s financial giants. Among them were Lehman Brothers, Bear Stearns and AIG.

According to Dr. Walden Bello, sociology professor of the University of the Philippines, the worst is not yet over. He said: “allowing Lehman Brothers and Washington Mutual to collapse while taking over AIG and engineering Bank of America’s takeover of Merrill Lynch — there is no strategy to deal with the crisis, just tactical responses.” He likened the move to a fire department’s response to a conflagration.

The US Federal Reserve Bank plans a $700 billion buyout of bad securities but is that really a wise move? This writer agrees that it is not really a strategy but merely a desperate effort for people to gain some confidence in the economy and prevent a massive bank run.

In layman’s terms, a financial crisis evolves from problems with mortgages. These are loans from banks that help borrowers buy homes or start a business.

The borrower must repay the loan, as well as additional charges called “interest.” Interest is rent paid to the lender for the privilege of using the money for a specific period of time.

Australian banks require credit card applicants to provide proof that they can make repayments before the card is issued. Similarly, U.S. lenders required prospective borrowers to prove that they earn enough money to repay the loan. If the borrower is unable to pay back the loan with interest, the bank forecloses the property or whatever collateral was pledged.

Investment banks get their money back with interest from mortgage-backed securities. But when sub prime mortgages collapsed, they got huge losses instead.

The problem occurred because investors as well as the originators of the mortgage pool, did not price the mortgages correctly to take account of higher risk.

For Lehman Brothers, Merrill Lynch, and Bear Stearns, the losses represented by these toxic securities simply overwhelmed their reserves and brought them down. And more are likely to fall.

We can safely predict that there will be more bankruptcies and more government takeovers. It will result in deeper and prolonged recession spreading beyond the US market. It is now being felt in Australia and we can only hope that it will not worsen in our shores.

This writer concludes that the Wall Street meltdown was caused by greed and lack of government regulation of its economic sector.

Without lending, however, the economy will be paralysed. If banks would not give out loans, the working class would never be able to build houses; farmers would not be able to buy seeds or feed cows that produce milk. The economy would stall and be brought to a stand still. Quo vadis?

Are the oil producing countries partly to blame? May be so.