US market crisis: Lessons from Lehman’s collapse

September 23rd, 2008 - 11:47 am ICT by IANS  

Beijing, Sep 23 (Xinhua) The US government’s decision to take its hands off the country’s fourth largest debt ridden bank Lehman Brothers and let it fall has sent a stark message to other financial institutions.”Lehman’s collapse was earth-shaking news for the world financial market. It blew away the myth that as long as they (the financial institutions) become large and reach far they can beg for government help when in emergency,” said Jia Guowen, a financial analyst on a national TV programme.

Lehman ate up too much bad debt and unfortunately became the only victim in this crisis so far, but it also taught others a lesson, Jia said.

In their relentless quest for expansion, the banks must make sure they ward off possible risks involved in the business instead of plunging into distress and waiting to be bailed out by the government.

Some analysts compared the financial crunch to a relay game in which everyone passed the risks to the next - from lending banks to investment banks to evaluation institutes to insurance companies.

When numerous houseowners failed to pay back their debts, the relay game came to a stop - the banks have to digest the depreciated real estates and the insurers also pay the toll, analysts said.

In an effort to stabilize the credit market and prevent further economic downturn, the Bush administration has planned to buy $700 billion of bad debt and encourage financial institutions to restore normal lending.

The sweeping cleanup plan will be the US government’s largest financial bailout since the Great Depression of the 1930s.

“This is a big package, because it is a big programme,” President George W. Bush said Saturday at a White House news conference.

“I will tell our citizens and continue to remind them that the risk of doing nothing far outweighs the risk of the package.”

Treasury Secretary Henry Paulson said the plan would address the root problems of the financial crisis gripping the country - bad debt on financial institutions’ balance sheet.

“As illiquid (which is not readily converted into cash) mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy,” Paulson said last week.

Critics say the US government has been inconsistent in its reactions to market events.

Investment bank Bear Stearns was provided with an emergency government loan this March. Mortgage giants Fannie Mae and Freddie Mac were bailed out on Sep 7.

The fourth largest investment bank Lehman Brothers Holdings was left with no choice but to go bankrupt on the night of Sep 14.

On the same day the third biggest investment bank Merrill Lynch was forced to sell its stake to Bank of America in a rush deal.

Two days later, top US insurer American International Group (AIG) narrowly obtained a last-minute deal of Fed’s $85-billion bridge loan to stay in business.

“I don’t think we can fault the Fed on working with Bear, Fannie and Freddie and AIG but not Lehman,” Ronald Schramm, a professor in finance and economics at Columbia University Graduate School of Business wrote in an article.

“Lehman was neither too big nor too urgent to fail, so it was allowed to fail. Fannie and Freddy and AIG were too big to fail and Bear too urgent to fail - so they were salvaged,” wrote Schramm.

The US Congress was working through the weekend on the bailout plan and was expected to pass the proposal in a matter of days but with some additions to safeguard the interests of US taxpayers as many lawmakers indicated.

Meanwhile, the US government joined hands with other countries to tackle the crisis globally.

The US Federal Reserve, the European Central Bank, the Swiss National Bank, the Bank of England, the Bank of Canada and the Bank of Japan Thursday pooled up to $247 billion to rescue the plummeting stock market.

Analysts said the effectiveness of government intervention in the market remained unclear, but many lessons could surely be drawn from the financial storm.

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