[Oct. 01, 2008]Two days ago, Dow Jones Index plummeted at - 9%, losing almost 777 points, triggering a dangerous financial crisis that may recall the inglorious Black Tuesday of October 24th, 1929, when US economy plunged, leading the way to the terrible years of the so-called the Big Depression.
Just to make it clear: On Monday, Wall Street lost even more points then the day after September 11. As expected, US crisis had a deep impact also on European and Asian markets. London, Paris, Frankfurt and Tokyo went down consequently.
Subprime crisis
In the meantime, economists and experts are trying to give a precise explanation of what is really happening, and most of all, what will happen next. Among the several explanations, all of them agree that present situation is a consequence of the subprime mortgage crisis, began last summer, when tens of credit agencies were forced to bankruptcy.
The subprime crisis, characterized by contracted liquidity in the global credit markets and banking system, was (probably) the result of the United States houses bubble (a rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability).
To keep the market lively, the subprime lendings (or subprime mortgage referring to real estate market) was soared. Andrea Rossettini, in his work Subprime Mortgage Crisis: Chronology, and International Recoil (La crisi dei mutui subprime: cronologia, aspetti e ripercussioni internazionali, the work is entirely in Italian), offers a precise survey over the financial and economic background that led to the present crisis.
A subprime is a very particular kind of lending, with a higher level of expectation of risk, thus, it is generally accompanied by higher interest rate charges. Subprimes were offered to borrowers with financial difficulties, not enough qualified for prime conventional loans.
Some years ago, an American family that wanted to comply with a subprime mortgage loan to by a new house had to present an exhaustive documentation of its economic condition. In 2006, things changed drastically: only the half of borrowers presented a detailed documentation, besides, while in the past a family could get a loan of nearly 126 thousand dollars, in 2007, they could get $209,000 even if their financial situation didn’t step up by a dollar.
Investors considered the subprime market as the opportunity for those consumers to have access to credit market, prevented otherwise. Beside, this kind of financial ventures lead to bankruptcy of many institutions, since their borrowers were forced to insolvency.
Last summer exploded the subprime crisis, sweeping along a wider economic crisis, since in the last years the building sector accounts nearly 50% of US GPD. For this reason, since the beginning of 2008, the whole US financial market went down, affecting also those banks and financial companies not directly involved in the subprime market. A whole financial system began to crunch. In few days, banks, financial services, insurance and brokerage firms collapsed.
The domino effect
On September 15, the 158 years-old global financial-services firm, Lehman Heads, fell into bankruptcy. Beside, Merrill Lynch, another financial-services firm was bought by Bank of America for roughly 50$ billion dollars to advert a deepening crisis.
A.I.G. (American International Group) the giant insurance company was able to survive thanks to a loan of $85 billions by the Federal Reserve (US federal bank), in a deal that would give the government control over the troubled insurance giant. It was an extraordinary intervention by the government in private enterprise, something almost unthinkable for the capitalist financial system of United States of America.
Few days later, the government seized the nation’s two largest mortgage finance companies, Fannie Mae and Freddie Mac, committing as much as $100 billion to each to backstop any capital short falls. On September 21, the Federal Reserve announced that Goldman Sachs and Morgan Stanley, the last big independent investment banks on Wall Street, would transform themselves into bank holding companies subject to far greater regulation.
Washington Mutual, the nation’s largest institution in savings and loan, became the largest bank failure in American history, as regulators engineered an emergency sale to JP Morgan Chase. On September 29, Citigroup, one of the biggest bank in the world, bought Wachovia’s bank asset for 1$ a share. After the earthquake, just few financial institutions remained solid, such as Citigroup, JP Morgan and the Bank of America.
Political issues
In the meantime the White House was trying to find out a solution. President Bush’s Treasury Secretary Henry M. Paulson Jr. proposed a sweeping bailout of financial institutions. He asked Congress for $700 billion to use to buy up mortgage-backed securities whose value had dropped sharply or had become impossible to sell.
By doing so, they said, the government would provide troubled firms with an infusion of capital, reducing doubts about their viability and thereby restoring investor confidence. Mr. Paulson and Federal Reserve Chairman, Ben S. Bernanke, warned lawmakers that failing to provide the financial community with additional capital would exacerbate a growing credit squeeze, depriving businesses and consumers of the money needed to sustain the economy.
Without a huge immediate bailout, the chances of a deep recession would rapidly increase, they said. President Bush underlined those warnings in a televised address to the nation on Sept. 24th. September 29th, the bailout failed, the House voted 228-205 against it. Stock markets plunged as it appeared that the measure would go down to defeat. The Dow Jones Index plunged at 9%, European and Asian stock markets followed.
Only news about a new deal on the bailout presented by Mr. Paulson pepped up markets injecting new confidence in American financial system to ride over the crisis. The Dow Jones Index reached +5%. And in the next hours the US Senate is expected to vote the plan.
This is a very crucial moment in US economy and politics. The next president, the Democratic Obama or the Republican McCain, that will be elected on November 4th, has to face a difficult situation. Most of all because this crisis showed many leaks in the US financial and economic capitalistic system.