Sunday, November 30, 2008

WORLD ECONOMIC CRISIS


The world is facing a situation close to that of 1929,if not exactly the same. Paulson proposed bailout package of $700 billion mainly to purchase toxic assets off the books of the financial firms. However the total consumer debt in U.S. is now about $2.6 trillion(22% more than in 2000),while the mortgage debt is around $10.5 trillion. The problem is that this debt will not be written off by bailout plan. The estimated credit default swap market alone is about $62 trillion. This poses a considerable danger.This is particularly the case as the major banks and investment houses now consolidate into 4 companies (J.P morgan chase,citicorp,Bank of America and Wachovia wells fargo). The toxic fictitious sector and the equally unstable consumer debt bubble are within the balance sheets of these 4 entities.The bailout does not address this toxicity,which will inevitably corrode the remaining banks.

This all started with sub-prime crisis,housing bubble and finally its effects on banks. On october 15 the federal reserve released the BEIGE BOOK which showed that in september consumer spending had declined in retailing,auto sales and tourism. This is the first formal indication of the impact of the crisis.Things are so bad that GENERAL MOTORS released a statement that"bankruptcy is not an option"for the company.

One of the main reason of all this is the complex structure of the U.S. economy,which gives extremly high profits to the financial sector. The number of bank failures in U.S. increased after 1980s;the savings and loans crisis was precipitated by financial behavior induced by liberalisation;and the collapse of long term capital management pointed to the dangers of leveraged speculation. Afterwards came the effects of housing bubble. Because of the complex chain,institutions at every level assumed that they were not carrying risk or they were insured against it. But risk did not go anywhere and resides somewhere in the system. Given financial integration,each firm was exposed to many markets and most firms were exposed to each other as lenders,investors or borrowers. Any failure would have a domino effect that would damage different firms to different extents and unfortunately the same happened.