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Dar Al-Hayat

America Pays for its Mistakes

Michel Morkos Al-Hayat - 29/09/08/

When the US Administration interferes a few times to save its national economy, at times bailing out major financial institutions and at others drafting rescue plans to float the economy, this means it has previously given up - for undisclosed reasons - its fundamental mission of protecting the economy. Instead of regulating markets and controlling large financial institutions, it has left investment banks prey to more debts and money markets under the pressure of hectic speculations.

Two months ago (July 26), Congress passed a bill to set up a $300 billion fund that provides citizens with soft loans to settle mortgage payments. Currently, the US Administration suggested a $700 billion program to save Wall Street. Through these two programs, the US government acquired two mortgage giants, Fannie Mae and Freddie Mac, and controlled American International Group, the largest insurance company in the world. At the same time, many mergers occurred within the private sector: Bank of America took over Merrill Lynch for $50 billion and JP Morgan acquired Washington Mutual. In addition, the shares of Goldman Sachs and Morgan Stanley fell and Lehman Brothers filed for bankruptcy.

Facing these financial crashes, along with the severe losses in world stock markets - with Wall Street leading the way - the US bailout plan comes amidst the continuous and following crises. This clearly indicates a (previous) huge letdown in the financial policy applied to US banks. It also shows the world-class US stock markets dealing with non-solvable money instruments.

Tracking the seeds of the US mortgage crisis sheds light on the gaps in the lenders' use of unsecured money instruments. Low-interest mortgages created an active real estate market. Thus, houses increased in value and were turned into mortgaged assets in order to achieve the welfare of households, owners of houses. With the expansion of mortgage lending; with loans offered to buy cars and luxurious furniture, to restore homes, and travel, banks issued bonds against their mortgages and sold them for global investors in return for revenues. Investors then sold or pledged them to investment or hedge funds in view to buying more such bonds. These same bonds are a result of mortgages or loans for durable goods, such as cars.

Mistakes started to pile up. The first one resulted from the expansion in lending at interests linked to the rates set by the Federal Reserve, which increased from one percent at the time to 4.5 percent at the start of the crisis last year. The second mistake was attracting the borrower with bank facilities on one hand and false facilities on the other: settlements for the first three years were only limited to the interest rate. With the rise of the non-fixed interest rate, some borrowers were unable to settle the due payments and faced high fines that increased their inability to pay.

The confusion in the assets guaranteeing the loan or the bonds was the third mistake. Lenders viewed mortgaged houses as a guarantee for their loans, while the owner of the mortgage bonds thinks they are his as well. When the regulations enforced insurance on mortgage bonds, major insurance companies took the burden of the bonds, which were considered pretty crash-proof.

Everything was dependent on the main borrower and his financial solvability. When that borrower defaulted on his payments, the bonds turned into a burden and became bad bonds. Lenders, in need of liquidity, crashed; hedge funds, investors and, consequently, mortgage bonds insurance companies suffered losses.

In short, banks were very lenient. Loans for a single house mortgage became 30 more than the real house value. Newsweek's Fareed Zacharia says that the ratio of corporate debts to share capital stands at 35 to 1.

The crisis is bound to end the dispute over saving the economy. But an administration like the American one must in the first place regulate banking operations and money markets where the reckless competition led to the crash of the world economy and threatens it now with recession and paralysis.

Not all US institutions incurred damages; not all economic activities faced losses. To redress the economy, the mistakes of the past must be first avoided. For economic freedom does not mean chaos.

http://english.daralhayat.com/business/09-2008/Article-20080929-ae93217f-c0a8-10ed-01ae-81abf7cc1eec/story.html

Dar Al-Hayat's English website is a primary source of information for all English-speaking readers seeking an alternative perspective and in-depth reporting on the Middle East and the Arab world.



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