Editorial:Rescue package rescued
As was widely expected, the US House of Representatives passed the legislation activating the $700 billion bail-out of the financial system, last Friday. The passage came after some features were added to the original version, which had been rejected a few days before, but the main reason for the swing in favour of the Bill was the dramatic response of global markets to the rejection. It became quite clear that, whether the programme would succeed or not was no longer the issue. Rather, without a government-backed rescue, the US and global financial systems would almost certainly collapse. The ‘moral hazard’ implications of the bail-out and its fiscal implications will continue to be debated. However, for Treasury Secretary Henry Paulson and the organisations and people he ropes in, in his efforts to save the system, that is all academic for the moment. The immediate and over-riding goal is to act. Deciding on what assets will be bought with the initial infusion of $250 billion is the first priority. There is a widespread belief that the total value of the so-called toxic assets far exceeds the $700 billion provided in the package. Given this, its ability to extract maximum leverage by focusing on assets which are dragging down the system the most, is absolutely critical to its success. The margins for error are extremely small. Buying up assets that do not provide ballast to others, thus boosting the entire system in the process, will make matters worse, while exhausting the limited resources of the package and its capacity to achieve its goals.
Reports suggest that Mr Paulson has been quick off the blocks, beginning to put in place the resources that he needs within hours of the legislation being signed into law. But, even with this commitment and speed of action, which has been facilitated by certain exemptions from the procedural requirements for government procurement, it will be at least a few weeks before the money starts flowing into markets. The urgency has been heightened by bad news coming in about the US economy, which, judging by auto sales and unemployment numbers, is slowing considerably after an unexpectedly buoyant second quarter. Further flows of bad news will put more pressure on financial markets, making Mr Paulson’s task that much more difficult, with every further setback reducing the probability of the bail-out succeeding.
Under the circumstances it is imperative that the US effort is supported by other governments and central banks. With concerns about the integrity of the European financial system deepening, the Paris meeting of European leaders seems to be finding it difficult to put together an acceptable package. If this stalemate persists, more bank failures in the region could spill over to the US, undermining rescue efforts. All said and done, even as the discussion on how to minimise the negative fall-out of the package goes on, there is now little question about its necessity. Whether it will work, though, depends on the confluence of a number of factors, many out of Mr Paulson’s control.