Column The new Washington Consensus

Font Size

Print

Feedback

Email

Discuss

: Finally here is something that looks like light at the end of the tunnel. US treasury secretary and former Goldman Sachs chief Hank Paulson and Fed Chairman Ben Bernanke, an expert in the economics of the Great Depression, have together put together a plan that, by early indications, US Congress cannot wait to approve—the mother of all bailouts to combat the mother of all crises. Add the proposed $700 billion to the sums paid to keep AIG afloat and the still unclear costs of nationalising Fannie Mae and Freddie Mac, and the bill to taxpayers quickly crosses the trillion dollar mark, well over a third of the US federal budget. The proposed $700 billion package itself is larger than the social security obligations as well as Medicare and Medicaid and only marginally less than the expenditure on national security. It necessitates an enhancement of the federal public debt limit by $800 billion. By all measures, this is one gargantuan deal.

Few need convincing that something of this scale was absolutely the need of the hour. The Fed had earlier helped the Bear Sterns rescue as well as provided a $85 billion bridge loan to the insurance giant AIG, but after the fall of Lehman Brothers and the takeover of Merrill Lynch and with Morgan Stanley tottering, it was clear that case-by-case support was not reaching the heart of the epidemic and the cancer had already reached across an unexpectedly wide swath of the financial terrain. During the Asian crisis a decade ago, we had witnessed massive cross-country contagion. This time, the contagion is cross-institutions and cross-instruments. Through the ingenious use of financial engineering, bad subprime loans have layers and layers of financial derivatives built on them and it is not clear where the ripple effect of subprime write-offs would end. Highly leveraged financial institutions are trying to simultaneously offload debt leading to a “fire-sale” situation in the private debt market. Government debt seems to be the only instrument in which people have any faith any more. The seizing of inter-bank credit can well trigger off a Japan-style long and painful recession—an outcome that policy makers should avoid at all costs.