The US government's decision to inject $250 billion in equity into its biggest banks and guarantee their debts is still textbook financial system bailout. The real wonder is why Washington didn't decide to announce this as it was trying to push through legislation (TARP) to buy banks' so-called toxic assets. It might have saved trillions of dollars in global equity markets and softened the impact of the crisis globally. It is true that the notion of having the government owning the nation's banks is unpalatable and at the time may not have seemed absolutely necessary. Had TARP managed to unfreeze the interbank market, it may not have been necessary to take over the banks so soon. Instead, some banks would have slowly been driven into the government's arms over time as TARP's activities revealed the extent of their losses, avoiding a major systemic collapse of confidence. Alas, the collapse of confidence came in one sharp shock last week. So the decision to move ahead is a welcome one. As a measure of how much calmer global markets have become, the dollar staged a sharp retreat against other currencies, indicating a sigh of risk relief. Europe and the UK, by contrast, had less ideological aversion to a state takeover of the banking sector and moved in one fell swoop to bail out their banks. They also had the benefit, perhaps, of a few days of 20/20 hindsight and knew that a piecemeal approach would likely leave them with several Lehman's. Luckily, Paulson was smart enough to take the 250 B's from the 700 Congress already approved, underscoring that the $700 billion was never meant to be a price tag, but rather a confidence-boosting armory of Depression-busting bucks. As mentioned here previously, the Feds will likely spend much less than that buying toxic assets, and probably make a bit of money here and there when some of those distressed assets turn good. Still, having failed to keep the banks from becoming partially government-owned, some feel it doesn't make sense now that the Treasury is settling for non-voting preferred shares to help avoid diluting equity and discouraging other investors from buying the banks' stocks. Government involvement is now a plus for potential investors, indeed it's the only thing seemingly keeping the banks afloat. I argued in favor of TARP and against critics of a Wall Street bailout because TARP was not a bailout. Most critics of the plan, including even some seasoned economists, didn't seem to understand that part of it. But this aspect of Paulson's bailout may indeed be bit unfair for taxpayers. The government, and by extension the taxpayer, should get a seat on the board and a say in how things are run. The danger, however, is that once Government is involved in running these banks, that it becomes difficult if not impossible to get them back out again. Keeping the shares non-voting ensures that the banks continue to be run like private banks (except for bankers paying themselves obscene sums and giving themselves golden parachutes), and obviates the need for some guarantees and timetables for a forced sale of the government's stake. And don't even mention moral hazard: at this point, we need the banks to take on more risk based on their government backing. The greater danger is that they stop lending at all to the economy. Oh yeah, that economy thingy. Now that the financial system is hopefully secure from collapse, the US must move on to reviving it. Lower rates may not be enough to actually kick start things. Massive fiscal stimulus in the form of government infrastructure spending might be a good idea, and US highways, bridges and ports certainly could use the investment. Further incentives for the housing market may also prove necessary to dig the US consumer out of the red. We also need to look now at how to resuscitate vital parts of the global economy that rely heavily on global credit: transportation, for one. Global trade is likely to be hit hard by the events of the past six weeks. Provided emerging markets can quickly revitalize funding to key industries, their savings could help hasten a recovery in global growth and accelerate their long-predicted economic decoupling from the now-moribund US economy. The UAE may still need to move more assertively into its own financial sector, both to shore up banks with capital injections against a likely correction in property prices, and to keep investments flowing around the region. This crisis has had a devastating impact on less affluent regional economies like Iran, and has brought Pakistan to the brink of collapse. Regional stability is crucial to the UAE.
warnold@thenational.ae
