September 30, 2008

Today's Wall Street crash

Quote of the day:

“This is a huge cow patty with a piece of marshmallow stuck in the middle of it and I am not going to eat that cow patty,” said Representative Paul Broun, Republican of Georgia.

The U.S. House of Representatives today rejected the $700 billion financial rescue plan, resulting in the Dow plummeting by 777 points, its largest single-day drop ever. The market lost $1.2 trillion in value. Just 1/3rd of Republicans voting backed the plan, which was proposed by their own President Bush.

Part of the reason for the failure in my opinion was wrong messaging. The rescue package was treated as a bailout for the wealthy Wall Street bankers at the expense of taxpayers. This is not entirely true. Credit squeeze due to toxic mortgage assets on the balance sheet of banks will affect the common person, at some level, more than wealthy bankers who have resources available for a rainy day. If banks freeze their lending, it'll impact car loans, small business loans, college tuition loans, and may also cause serious layoffs as firms cut projects due to capital shortage.

I believe some sort of rescue plan will be passed eventually. But the Federal rescue package in itself, though required, does not guarantee a sustainable recovery. My fear is that the American financial turmoil would spread over to Europe, which seems to be where the U.S. was a year back, and maybe the rest of the world. Though several emerging economies (BRIC nations) have domestic markets to sustain some of their growth - the "de-coupling" theory between developed and developing world markets that economists talk about - America and Europe are still the primary drivers of the global economy. If they sneeze, rest of the world will catch cold. U.S. mortgage-backed securities also found their way into the books of several global banks, not just those of Wall St firms. And many European banks are just too big for their individual governments to be able to bail them out. And a pan-European rescue, existence of the European Central Bank & European Union structure notwithstanding, would be extremely difficult due to the complexity of working through different regulations and political issues of individual countries.

Japan took more than two decades to recover from its similar real estate collapse driven economic meltdown of the 80s. I suspect U.S. will face the same fate, but we're clearly entering a highly uncertain economic environment.

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