The Financial Crisis Morphs into an Economic Crisis

Updated October 30

The global financial system is beset by a crisis that appears to be resistant to the therapeutic effect of the $700 billion bailout approved by the United States Congress, and the equivalent measures taken by the governments of the European Union. In fact, financial instability is beginning to affect the global economy with falling demand, falling investment and growing joblessness. Increasingly, the financial crisis is becoming an economic crisis impacting on people’s jobs and way of life. Even credit cards, one of the major engines of commerce, are being made subject to stricter controls. In this context, American Express, Bank of America, Citigroup and even the retailer Target "have begun tightening standards for applicants and are culling their portfolios of the riskiest customers. Capital One, another big issuer…has aggressively shut down inactive accounts and reduced customer credit lines by 4.5 percent," according to the NYT. The crisis that began on Wall Street two months back is also having a severe impact on the economies of developing countries, especially the non-oil producing countries.

Volatile Stock Markets: A continued loss of confidence has made the markets volatile across the world. Stocks tumbled from Tokyo to New York, especially on Friday, October 24 and Monday. According to the New York Times, investors continued to turn to the security of the United States dollar and the Japanese yen and drove down currencies of developing countries like Brazil, Ukraine and South Korea and even of developed countries like Britain.

But the BBC has reported that on Tuesday, the European stock markets rebounded, regaining some of the ground lost in recent days. The UK's FTSE 100 index was up 1.8%, while in Germany a sharp rise in Volkswagen shares pushed the Dax index up 5.1%.

Earlier, Asian stock markets had rallied, with the Nikkei 225 falling below the 7,000 level before recovering to close up 6.4%. Hong Kong's Hang Seng gained 14.4%, its biggest daily percentage increase for over a decade. On Monday it had declined 12.7%. Even after Tuesday's gains, the Nikkei and Hang Seng have fallen more than 30% since the beginning of the month, reports the BBC.

Wall Street experienced one of its biggest rallies since World War II on Tuesday, up 889.35 points or 10.9 percent. Probably the bulls, like Warren Buffet, felt that it was time to buy again, despite signs of trouble in the economy. Many other investors, however, remained unconvinced, according to the NYT.

Growing Unemployment: Many leading companies of corporate America are laying off workers. They include Yahoo, General Motors, Ford, Xerox, General Electric, Bank of America, Pratt & Whitney, even Coca-Cola, not to mention the airlines.

It is feared that when October’s job losses are announced on November 7, the number may top 200,000. The current unemployment rate of 6.1 percent is likely to increase.

As cited in the NYT, economist Nigel Gault of Global Insight is of the view that unemployment will be near 8 or 8.5 percent by the end of 2009. But as companies lay off workers to cut production in response to slackening demand because households earn less, a downward multiplier effect will kick in. As the ranks of the unemployed swell, demand for consumer goods will be depressed and a deeper recession will become inevitable.

General Motors in deep trouble: As a prelude to the financial crisis on Wall Street, General Motors, the world’s largest automaker, has been floundering in a sea of red ink by losing $18.8 billion in the first half of this year. The once prized jewel in "America's industrial crown" is trying to avoid the fate of Lehman Brothers through a possible merger with Chrysler, another company in trouble. The US government is considering ways and means of helping the two companies effect a life-saving merger.

As of Friday, G.M. shares had declined 76 percent in 2008 and Ford shares were down 70 percent. The reason for this looming catastrophe is poor judgment on the part of G.M.’s planners who put most of their eggs in the S.U.V. basket. As the price of oil crossed the $140 per barrel mark, consumers stopped purchasing these petrol guzzlers, and many unsold vehicles clogged the dealers’ lots across the United States.

Banks are not giving loans: Treasury Secretary Henry PaulsonHenry Paulson had decided to use the first installment of the $700 billion bailout money to recapitalize banks in order to get the banks to start making loans again, and help prevent this recession from getting much, much worse.

In a scoop, Joe Nocera of the NYT times has revealed that banks have no intention of using the money to advance loans. This was inadvertently confirmed by an executive of J. P. Morgan-Chase in a confidential briefing, which Nocera overheard. In point of fact the banks are planning to hoard the federal money to make profitable acquisitions as and when circumstances permit. More amazingly, this is what the administration wants. It declared objective that it wants banks to "start lending again — is a fig leaf, Treasury’s version of the weapons of mass destruction." According to Nocera, the Treasury wants banks to acquire each other and is using its power to inject capital to force bank consolidation.

In a twist to this bailout, American Bankers Association complained on 30 October that bankers around the country were extremely upset that the Treasury Department was trying to offer them billions of dollars in fresh capital on terms that were not acceptable to them.

"These bankers believe they are being asked — in some cases pressured — to participate in a program they did not want and do not need," wrote Edward L. Yingling, president of the American Bankers Association, to the Treasury secretary.

Mr. Yingling said many healthy banks might want to take advantage of the Treasury’s offer, but not if they had to suspend dividends or accept restrictions on executive pay.

"It would make no sense for a well-capitalized bank with solid earnings to agree to a program which would greatly lower the value of its stock, Mr. Yingling wrote.

Crime and Punishment: According to The Economist dated October 23, the US government will feel immense pressure to put a few bankers in the dock for their role in the Wall Street Crash of 2008. Government agencies are probing many firms, including Fannie Mae, American International Group and Lehman Brothers. At least 17 former Lehman executives, including its former head Dick Fuld are expected to receive grand-jury subpoenas.

But to find evidence of fraud one has to prove intent to deceive, which may not be easy, "even to a jury disinclined to give fat cats the benefit of the doubt. Likewise, sloppy risk management, though lamentable, is not illegal." It is unlikely, therefore, that the key people responsible for the biggest financial crisis since 1929 will be brought to justice.