U.S., Bowing to Pressure, Will Buy Banks
BOSTON, Oct 11 -- The George W. Bush administration announced Friday evening it would buy shares in troubled U.S. banks, a move that upstages its own rigid, free-market ideology, and answers calls for the action by European leaders.
Until now, the U.S. has resisted taking the action even though doing so would be a prudent plan for stabilizing financial institutions, said Thomas Palley, founder of Economics for Democratic and Open Societies.
"What you are really seeing is how ideology can get in the way of good policy. Republicans have been averse to gaining an equity stake in the banks," Palley told IPS.
U.S. Treasury Secretary Henry Paulson made the announcement following a meeting with the finance ministers of the G7 richest nations, who said "urgent and exceptional action" is needed. The governments issued a brief, five-point plan for stabilizing markets, including allowing banks to raise capital from public and private sources as necessary.
"It is aimed at recapitalizing the financial institutions in the U.S.," Paulson said. "We want to do this as soon as possible but we want it to be right and to be effective."
"This is a period like none of us has ever seen before," he told reporters. On Saturday, G20 finance ministers are meeting with Pres. Bush.
The week was marked by severe turmoil in markets throughout the world, especially in Iceland, Indonesia, Pakistan, Romania, Russia and Ukraine.
In the U.S., an auction Friday of risky investments held by Lehman Brothers, which declared bankruptcy, were sold for 8.625 cents on the dollar.
Britain unveiled a plan to inject up to 87 billion dollars into its banks, and it has been urging other nations to do the same.
"In Britain, there is no such political obstruction, so they went ahead," Palley said. "British Prime Minister Gordon Brown will be a political beneficiary of his courageous action."
On Wednesday, in an effort to free up lending among big banks, the U.S. Federal Reserve and central banks in Europe coordinated an interest rate cut. But European nations have otherwise acted singly, with each tackling their troubled markets with any of a variety of measures to free up lending and shore up banks. According to the G7 statement, they will continue to act on their own.
"Each of the 27 European Union markets have different ways of banking," said Christine Lagarde, France's finance minister, while in Washington Thursday. "As a result, obviously we deal with issues in different ways. If you look at the Danish market it has 140 banks. Sweden has 14 banks," she said.
Paulson said the U.S. will use part of 700 billion dollars allocated by Congress on Oct. 3, to buy non-voting shares, also called recapitalization, in banks and other struggling U.S. institutions.
The purchases mean that U.S. taxpayers will own part of the banks. It is a necessary step, Lagarde said.
"Recapitalization, however strange it may seem for countries that are more free market, is one of the key tools that will be used," she said.
The global wildfire in the world's markets is widely believed to have started in the U.S. after financial institutions created a new type of investment product made from bundles of unrelated mortgages, including a significant number of mortgages that were high risk and likely to go into default.
Many of the risky mortgages had very unfavorable terms and were aggressively peddled to unsuspecting consumers in the U.S. and elsewhere. Now, millions of people are defaulting on their mortgages. Banks throughout the world invested in the risky mortgage products.
"The financial crisis has reached a critical point. The sharp decline in the stock market and its volatility dramatically make the point. More important if less visible, the flow of credit through the banking system and the financial markets is seriously impaired, even in part frozen," said Paul Voelker, former chairman of the Federal Reserve, in a letter in the Wall Street Journal Friday.
"Never again should so much economic damage be risked by a financial structure so fragile, so overextended, so opaque as that of recent years," Voelker said.
In his address Friday, Paulson continued to refer discretely to a "housing correction" as the cause of the market crisis.
Paulson's original plan was for the U.S. government to use much of 700 billion dollars to purchase the risky and potentially worthless mortgage products from Wall Street firms and banks. The plan met with strong criticism from many economists, as an ineffective approach and bailout to Wall Street.
The markets are still reeling because the U.S. has done "too little, too late", Palley said. "Because of the extreme danger, now is the time to use everything policymakers have at their disposal."
In the U.S., "it's quite clear that we have to restore more power to government," he said.
Noam Chomsky, noted author and MIT linguist, wrote in the Irish Times this week, that origins of the market meltdown "lie in the triumph of financial liberalization in the past 30 years, that is, freeing the markets as much as possible from government regulation."
Chomsky discussed the Bretton Woods plan that followed WWII, to protect social concerns in democracies, while capitalism flourished.
Bailing out large financial institutions, as Paulson has proposed, is socializing their losses, something the U.S. has regularly undertaken.
Chomsky pointed to a troubled U.S. political system as standing in the way of truly addressing the abuses by financial institutions.
"In a functioning democratic society, a political campaign would address such fundamental issues, looking into root causes and cures, and proposing the means by which people suffering the consequences can take effective control," he said.
"Financial liberalization has effects well beyond the economy. It has long been understood that it is a powerful weapon against democracy," Chomsky said.
Robin Hahnel, professor emeritus of economics at American University in Washington, says the Bush administration is to blame for much of the financial mess. The Bush administration has removed essential regulations and prevented necessary oversight of financial institutions, Hahnel said.
The lack of regulation, of hedge funds, credit default swaps and mortgage lending encouraged some businesses to take advantage of the situation, he said.
"Free-market finance is an accident waiting to happen," he told IPS. "Bush put people in charge of these agencies who didn't believe in regulation. They completely gutted the enforcement apparatus."
"The U.S.-centered theories about free market finance are flawed," Hahnel said. "The response of the European government authorities is a much more sensible approach compared to the Paulson approach. Capitalizing the banks is the correct approach."
In addition to buying up bank shares, France will not hesitate to restructure its banks as necessary, Lagarde said. This is not a march toward socialism, she said.
"We believe it is not a core attribute of the state to own a stake in the market. But it is necessary to take a stake now, sort it out and put a new management in if necessary," she said.
France also will write new finance regulations to deal with hedge funds and other new types of trading instruments, she said.
"We need more rules and better rules. Quite a few of the difficulties [in the markets] result from the absence of rules. The sub-prime mortgages, the fact that they are outside the scope of regulation is of concern and needs thoughtful redress," Lagarde said.
It recently announced tough new rules to reign in executive compensation of banks, she said.