Regardless of how much the U.S. government ponies up to salvage the financial sector, the global economic hangover may linger for years.
Stock markets worldwide soared on Friday as investors envisioned hundreds of billions, if not $1 trillion, in U.S. taxpayer money to build a hazardous financial waste dump that would take bad debts off banks’ books.
“The crash phase of the Great Financial Crisis of 2008 would appear to be over,” said Stephen Stanley, chief economist at RBS Greenwich Capital.
But as U.S. lawmakers scrambled to cobble together a rescue package that could reach Congress as early as this week, there were far more questions than answers about what assets the government might buy, from whom, and at what price.
Would it cover only mortgage-related securities? What about U.S. credit card debt or auto loans, where delinquencies are on the rise and likely to worsen as job losses pile up? Would non-U.S. firms be able to offload their tainted debt?
Federal Reserve Chairman Ben Bernanke can expect a host of questions along those lines when he testifies before congressional committees this week. He was scheduled to address committees on Tuesday, Wednesday and again on Thursday.
Sen. Charles Schumer, the Democrat who chairs the congressional Joint Economic Committee, said after meeting with Bernanke last week, he understood what was at stake if lawmakers did not come up with a quick rescue plan.
“When I heard his description of what might happen to our economy if we failed to act, I gulped,” he said.
Whatever form the rescue takes, it will certainly help to clean up banks’ balance sheets.
However, it will not herald a return to the easy money days that helped to drive a global economic boom for most of this decade. Until lenders are confident that they will get their money back, they will continue holding tightly to their cash.
With U.S. elections looming in November, politicians are keen to convince voters that they did not squander tax dollars to rescue rich bankers and will no doubt insist that financial firms shoulder some of the losses.
“’Wall Street fat cats’ are now going to be ’Public Enemy No. 1,’ and a bipartisan crackdown is coming,” Stanley said.
That means chastened banks probably won’t be in any hurry to hand out money indiscriminately again, and it points to a prolonged period of tepid growth, not just in the United States but throughout the developed world.
Even developing countries whose banks didn’t buy bad mortgage debt are facing more modest growth as risk-averse investors turn away and trading partners in the United States, Europe and Japan retrench.
“Put simply, emerging economies cannot defy gravity in an increasingly multipolar world,” said John Lipsky, first deputy managing director at the International Monetary Fund.
It will be a few more weeks before economic data is available to quantify exactly how hard the latest drama hit the real U.S. economy. The market turmoil drove up borrowing costs for banks and other companies, and unless conditions improve, the tighter credit terms will weigh on economic growth.
Richard Curtin, director of the Reuters/University of Michigan Surveys of Consumers, said how consumers respond to the crisis “will help to determine the length and depth of the ongoing economic downturn.
“While the financial crisis is likely to make the ongoing downturn a little deeper and persist a little longer than originally anticipated, perhaps the most important implication is that the eventual resolution of the crisis is likely to slow the rate of growth in consumer spending for years to come.”
Already the crisis has taken a big bite out of Americans’ nest eggs. Government data released last week showed that household wealth declined for three consecutive quarters through June, the first time that has happened since records began in 1951. The current quarter will probably show losses as well, thanks to the housing bust and stock market unrest.
In a sign of how nervous investors have become, the U.S. government on Friday had to pledge $50 billion to backstop money market funds that are normally considered as safe as cash but were buffeted by record-large withdrawals last week.
Jack Ablin, chief investment officer at Harris Private Bank, said the government’s promise of a swift rescue had brought financial markets “back from the brink” but would not fix everything.
“This does not represent a catalyst to a new bull market, but it will go a long way to reduce volatility, uncertainty and fear,” he said.
