All eyes are on the US, will this $700 billion package come through or not? Though most know that US does not have any other option today, the question is will the entire $700 billion be sanctioned all at one go or would it be in tranches? At the same time, there are many more core questions which have come to the fore now. Questions you wanted to ask but did not know where to ask. So here goes…
Will the bailout work?
The US Federal Reserve has asked for a bailout of an eye-popping $700 billion. Treasury Secretary Henry M. Paulson Jr and Ben Bernanke are busy convincing the Senate to agree to the bailout and they are convinced that this bailout is the only and right answer to help America go ahead, to pull it back from the deep abyss it is today in. But no one really knows how exactly this bailout package has been designed. The only thing we know is that the Govt will use the money to buy the mortgage-linked investments and it will then try and sell the assets, trying to recover as much money it can. Surely, given the slump in the housing markets and not knowing how much more further it could slip, putting a value to the amount of money, the Govt would be able to recover, is akin to predicting the weather. The tax payer does not know today how much would be his ultimate price tag and even after paying the price, it does not ensure that all will be well.
The $700 billion bailout package does not guarantee anything. But what it would do is bring back confidence and re-establish the badly pummeled faith of the world back into the system. So basically the bailout is a confidence building exercise. This is needed as banks have the liquidity but are unwilling to lend as they do not know who would go down next. So this bailout would help restore the faith back, announce to the world that all which was bad has already happened and now America is on a rebuilding mode. This will thus ensure that banks start lending again and bring back the much needed liquidity into the system.
Right now, in America, too many people are out of jobs, too many people are unable to pay their mortgages and too many banks have collapsed. So the main objective of the bailout is to get liquidity back into the system, so that the housing slump is arrested and people come back to buy homes.
What is the credibility of the credit rating agencies today?
After the collapse of legendary financial institutions, how can we ever trust the rating agencies, who all along have been giving these collapsed institutions a AAA rating, the gold standard? To a large extent, it would be no exaggeration to lay the blame of this entire crisis on the rating agencies. A report put out by Bloomberg states that the top two rating agencies on New York – Moody’s and Standard & Poor’s, since 2004, have adjusted their rating requirements for securities backed by commercial properties because of the “threat of losing deals.” Wall Street underwrote $3.2 trillion of loans to homebuyers with bad credit and undocumented incomes from 2002 to 2007. If these grading’s had not been adjusted to AAA, the money flow would have stopped and this entire financial mess could have been avoided.
Bloomberg has stated that after the defaults started, S&P and Moody’s downgraded more than three-quarters of the AAA-rated CDO bonds issued in the last two years. So what is their credibility today? A secure investor puts money only in FMPs, only in companies which have been graded AAA but what to do when that rating itself is flawed?
Apart from these two, one cannot help but wonder about the Great American Transparency system. When it came to transparency, America was stated to be the place to learn one’s lessons. So if there was so much transparency, how come no one saw this coming six months ago? When Lehman, Merrill Lynch, Washington Mutual or AIG presented their numbers, wasn’t the rising NPA pointing towards a collapse? What happened to Corporate Governance? And what about the top notch executives working in Lehman and the likes? They were looked up with a kind of reverence. What is their credibility today? Haven’t they sold off their credibility for a few dollars more?
The collapse of the American financial system is more about a complete erosion of values and this is probably what the $700 billion bailout is attempting to restore.