The level of government intervention resulting from the financial crisis has no recent precedent in this country. It was reported by Forbes that the sum of the liabilities assumed by federal authorities during the past six months–from transactions involving mortgage giants Fannie Mae and Freddie Mac, the insurer AIG, investment bank Bear Stearns and 11 failed regional banks–now exceeds 50% of gross domestic product. That’s a scary situation.
The Bush financial-sector rescue plan, which was revised and finally approved by Congress, could push the fiscal deficit in 2009 up to $1.5 trillion. However, many economists believe the eventual scale of government intervention will likely be much larger. At press time, market conditions were continuing to deteriorate with a great deal of uncertainty in every sector of the economy. There are several conclusions, according to Forbes, that can be drawn about the likely course of events:
There was clearly an attack on Bear and Lehman from hedge funds and other financial players who hoped to profit from their demise. The government must investigate the activities of the hedge funds or formulate a strategy for controlling them. Their potential to disrupt markets is evident. Short-selling is a key trading tool and hedging device, and often helps to stabilize markets–but the political backlash will pose major challenges for the hedge fund industry.
Meanwhile, the debt of the household sector has increased from 60% of GDP during the early 1990s to almost 100% last year. Household borrowing is still positive, but the growth rate has plunged from nearly $1.2 trillion per annum three years ago to just 500 billion dollars. Consumer borrowing actually dropped in September for the first time since 1998 – because of a lack of credit sources – and that’s bad news for the economy. Corporate debt also increased from 53% of GDP during the mid-1990s to over 70% – more bad news. Hopefully, all of this leverage will significantly wind down in 2009.
The current U.S. de-leveraging spiral is more than a mere liquidity crisis: It is systemic, and so far the piecemeal government intervention pursued has largely failed. Using the huge bailout package to recapitalize banks by taking direct equity stakes is a start, but arresting economy-wide de-leveraging will require more major fiscal policy and regulatory responses. The next President and the new Congress must have definite plans to get our nation’s economy back on track and put it on solid ground. I am convinced that Senator Obama will be able to bring capable people into government roles that have the ability and competence to turn things around.
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