Experts: Federal Bailouts Avert Financial Meltdown, Severe Economic Downturn

The government bailouts of the nation's banks, along with the rescue of insurer American International Group Inc., were greeted with euphoria by investors Thursday and Friday. Experts say the moves should allow the economy by avoiding what could have been a massive collapse of the financial system.

The downside, of course, will be the cost – which easily could top $1 trillion, according to reports. But the alternative could have been a lot worse, said Charles Ballard, professor of economics at Michigan State University.

Ballard said the massive bank bailout announced Friday avoided a "domino effect" that could have brought down a large number of financial institutions, one by one. Averting that scenario is good news for the economy – including creditworthy companies in need of loans.

“If this works,” Ballard said, “…it’ll be a lot easier to get a loan than if the domino effect had been allowed to go on.”

Ballard said he thinks the government’s actions will help limit the duration and severity of what could have been a very severe downturn. But that said, he thinks that a recession is unavoidable and borrowers will continue to have a much harder time getting bank loans than they would have a few years ago.

“I think everybody wishes it had not come to this,” Ballard said.

Investors Relieved

The Bush administration asked lawmakers Thursday for the power to rescue banks by buying distressed assets that lie at the heart of the financial system's crisis. The details of the plan were still being worked out Friday, but Washington lawmakers from both sides of the aisle said they were eager to work out a deal.

"It definitely gives investors a light at the end of the tunnel," said Daniel McCormack, a strategist for Macquarie Securities in Hong Kong told the Associated Press. "The solution is of such a magnitude that it could eventually fix the problems ... That's hugely important at the moment because that's what markets are focused on."

On Friday, the Federal Reserve said it will expand its emergency lending and let commercial banks finance purchases of asset-backed paper from money market funds. The Fed also will buy short-term debt obligations issued by mortgage-lending giants Fannie Mae and Freddie Mac as well as the Federal Home Loan Banks.

And to help calm investors' anxieties, the Treasury Department has decided to use a Depression-era fund to provide guarantees for U.S. money market mutual funds. Money market mutual funds are typically considered safe, but many investors have been fleeing them due to worries about the funds' exposure to the embattled financial industry.

To help limit the freefall in financial stocks, the Securities and Exchange Commission announced it is temporarily banning the short-selling of nearly 800 financial stocks. Short-selling is the common practice of betting against company stocks by borrowing its shares, selling them, and pocketing the difference when they fall.

"The federal government has been petitioned by Wall Street to take evasive action in the money markets, the stock and bond markets, to avoid a complete meltdown of the credit system," Joe Battipaglia, market strategist at Stifel, Nicolaus & Co. told the AP. "Once the credit system melts down, the economy falls. We can hand-ring about if this is the proper thing for the government to do, or if Wall Street pulled the panic button too soon, but that's something for the historians to sort out."

Keith Bowman, equity analyst Hargreaves Lansdown Stockbrokers said: "The short-term changes to short selling are certainly giving markets and regulators room to breathe. But there are going to be a significant number of hurdles to overcome for this temporary measure to prove useful at solving the fundamental problems over the long term."

Earlier, in the week, the Fed agreed to provide a two-year, $85 billion loan to American International Group, a massive insurance company, in exchange for a nearly 80 percent stake in the company. That was in addition to the government’s previously announced rescues of investment banking, brokerage and securities trading firm Bear Stearns and the federal takeover of Fannie Mae, Freddie Mac.

In a Rose Garden statement on Friday, President George W. Bush acknowledged the historic nature of what the government has been doing.

"America's economy is facing unprecedented challenges. We're responding with unprecedented measures," Bush said.

Bush called on Congress to quickly “pass legislation approving the federal government's purchase of illiquid assets, such as troubled mortgages, from banks and other financial institutions.”

Ballard said many people wonder why the government did not just step back and allow the market to work, weeding out weak institutions that will end up being saved by the federal bailouts. While that’s tempting, he said, the fallout would have hurt a large number of banks and other institutions that never made any risky loans and were acting fairly responsibly. That, in turn, would have hurt the customers of those banks.

“If you are a regular customer of a bank and that bank goes under,” Ballard said, “that’s a real problem for your business.”

The bailouts led to a huge rally in Wall Street which gave the Dow Jones Industrial Average a massive gain of about 780 points on Thursday and Friday. Those gains nearly wiped out losses of more than 800 points suffered through Wednesday of last week.

Print Page

Email This Page

Daily Dash Newsletter

Experts: Federal Bailouts Avert Financial Meltdown, Severe Economic Downturn

The Daily Dash - Wednesday, Feb 25, 2009, Feb

The Daily Dash - Tuesday, Feb 24, 2009

WWJ e-newsletters sign up