AN AVALANCHE THAT WAS….

As the whole world suddenly awakens to the ruthless face of Free market economics and its nasty verdict, it is indeed ironic that the world’s largest proponent of laizze faire should have found itself falling prey to the “invisible hand” , better known as “efficient” market forces .

The historic Bear Stern’s takeover (bailout) by JP Morgan early this year virtually tricked many, if not all into believing that the worst of the crisis had come and gone, when in effect it only foreshadowed the fate of many that were to follow.

It was a week that underscored the alarming intensity of the credit crisis to an extent that it brought back haunting memories of the Great Depression to the world of Banking and Finance.

It appeared as though the whole financial cave-in was just waiting for the slightest trigger. And well, the honors were done by none other than the Fannie-Freddie combine, who effectively communicated a short but strict “THE GAME IS UP, Folks……..!! “ message to the over-glorified, over rated investment behemoths who ruled Wall Street for decades, packaging almost anything under the sun in the name of exotic “high-yield” products.

With Lehman filing in for chapter 11 bankruptcy and Merrill Lynch selling itself in less than 24 hours to Bank of America - fearing to face a similar ruling like Lehman if it had to face the markets on the first trading day of the week, the cascade had set in motion. An interesting point to note is that Lehman had survived two world wars, the Depression, a currency crisis and the Sept. 11, 2001 terrorist attacks that destroyed its former headquarters in New York. It was even acclaimed just a year ago, as being one of Wall Street's best-managed firms .

Even as the world watched, visibly stunned at the Fed/Treasury’s conscious decision to stay off and let the 158 year old company become history, America’s biggest insurer AIG sheepishly lined in next, seeking for a rescue.

Despite the dirty turn of events, the FOMC decided to keep its benchmark rate unchanged at its regular meeting slated that day, much against expectations. However, in the next couple of hours decided to do what no central bank had ever done before, namely insuring the Insurer by loaning out $85 billion to be repaid over the next 2 years.

As panic and fear spread across, the apparently safe money market funds came under strain, losing its foremost characteristic of being highly liquid. Reserve Management Corporation said that due to the Lehman bankruptcy, the value of its sponsored Money Market Fund shares had fallen below par, which in turn triggered redemptions, worsening the liquidity-starved interbank market.

As investors pulled out of money market funds, they quickly sought cover in the T-bill markets, which saw 3-month rates drop to a record low of 1 basis point. This prompted central Banks all over the world to inject dollar liquidity worth $180 billion into their systems in an attempt to kick start the critical working of the money markets. Apart from this, the Fed also came up with temporary guarantee program for US MM mutual funds, by which it insures for one year the holding of any public offered eligible money market mutual fund, retail and institutional.

The slew of measures didn’t quite restore the needed confidence as it only meant a stop-gap solution aimed at addressing the liquidity crunch in the system. The precedent set by the FED clearly saw the system crying for something more – of the kind which addresses the very root of the problem, namely the junk asset/mortgage backed securities (now, not even worth the paper on which it is written on!!! ), which is all over the balance sheets of Wall Street.

Even as the “ingenious” (?) $700 bn rescue plan hangs in balance; there is one very interesting and vital lesson to take home. That if the “invincible” Wall Street is today, more or less razed to the ground, then that is the power which the Market mechanism possesses-one that does not discriminate between how big or small you are. Doesn’t really care for how long you’ve been in existence. It can be the most rewarding force and yet be merciless, simply because it operates not with a heart but a mind, which understands only one language-the language of efficiency and discipline. And therefore, any excesses in the form of too much greed or over-leveraging or excessive-spending or for that matter absolutely anything beyond what is to be, the MARKET will most certainly bring back into equilibrium, even if it means much pain and elimination.

While pushing through a rescue to the tune of $700 bn may just about help ward off an immediate collapse of the system, the cost however would be manifold

- the Fed risks setting a precedent, which implicitly encourages sub-efficient processes/systems/products to continue unchecked.
- Reckless policies to continue without any accountability and lastly
- push the US economy into a predicament of even greater proportions as it would then need to attract an approx $30 bn per month (approx $ 10 bn pm on the Iraq war is spent) for the next 2 years to fund the same. This is wholly apart from existing deficit it runs on virtually all its accounts(fiscal, trade and current)


Mr. Paulson and Mr. Ben Bernanke would do well to consider the many implications and respect the House’s verdict on the rescue plan coz if the INVISIBLE HAND could whip Wall Street, then the so called Sovereign, Risk-free US Treasuries may not be far behind as it may become the most riskiest asset around eventually……


……………..Makes sense, coz logically who would come forward to bail out the Federal Reserve??!!