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COLUMN

Saving the last frontier of capitalism

SIDDIQUE HAYAT KHAN
The $700 billion bailout package seems to have failed to put out the fire that has engulfed the whole financial world. Stocks continue to slide, liquidity drying up, and jobs are evaporating fast. Nobody knows when and where it will end.
The epicentre of the crisis, then (1930s) and now: There is little doubt that the great depression was triggered by the collapse of the US stock market. On an apparently normal day in Oct 1929, prices of stocks suddenly started plummeting. In a matter of hours, stocks ofblue chip companies fell to a quarter of their face value.
By the end of the day panicked selling turned shares into almost valueless pieces of papers. A dozen brokers, who became penniless, shot themselves on that fateful day (black Tuesday). Within months thousands of banks, insurance and mortgage companies went bankrupt; thousands of factories and farms were shut down. In a year US GDP was down by half and one out of every four able Americans became jobless.
What actually turned the economy around was the WW II, which fuelled demand for everything from tanks, guns, ships to boots and cloths. Industrial output rose generating employment that again led to household demands bringing quick recovery; die rest is history.
Who's the culprit now? The crisis was initiated by the US mortgage market and all fingers are pointing at mortgage
giants Fannie Mae and Freddie Mac. These two firms together hold $5 trillion worth of mortgage, almost half of the total US mortgage loans.
Interestingly enough, Fannie Mae was established in 1938 as part of President Roosevelt's New Deal policy to help small families buy homes and both companies run under government charter. They also operate in the secondary market by repackaging loans and selling them to financial institutions to generate liquidity for further lending, a technique known as Mortgage Backed Securities (MBS).
Because of the backing of the US government, MBSs of Fannie/Freddie are held by banks, insurance and other financial institutions. In the process, a significant amount of low quality or subprime loans may get into their portfolio.
How have these toxic loans originated? Arnold, a construction supervisor earns $650 a week. Sukhbir drives cab for four years and makes $2,000 per month. Van Dong's average annual income from a small food shop is $50,000. Ideally, these individuals would need to show a stable job and a minimum income for a substantial period of time to qualify for housing loan.
But thanks to a network of thousands of (greedy) mortgage brokers, whose commissions are directly linked to the volume of businesses they bring in to their companies, Arnold, Sukhbir, Van, and millions of them became
homeowners in no time. Since banks, mortgage and insurance companies are closely involved in the process of generating, repackaging, and insuring these loans they soon became part of the chain.
So long as people had stable income and kept on paying their mortgage payments, there was no problem. But when the economy took a downturn, their income declined, some lost job, and defaulted in payment. House prices plummeted, thousands of low income Americans faced foreclosure, and a sub-stantial portion of Fannie/Freddie assets turned toxic.
The collapse of Fannie/Freddie sent a strong shockwave across the financial market. In a desperate attempt, the government intervened, but failed to keep the confidence afloat. As their share prices evaporated, banks and financial institutions holding Fannie/Freddie securities found themselves in trouble.
The last two weeks have been most dramatic in terms of bankruptcies, buyouts and bailouts. The 158 years old Lehman Brothers filed bankruptcy. Bank of America bought troubled Merrill Lynch for $50 billion. The last two remaining investment banks, Goldman Sachs and Morgan Stanley sought to change their status into commercial banks and operate under the regulations of the Federal Reserve. The largest insurance company AIG (American International Group) was
rescued by the government on the brink of collapse. As economist Jeffrey Sachs warned, “The US economy is definitely going into recession and there's more turmoil ahead", the world witnessed fall of many giants. In Europe the victims are Bradford and Bingley, the Dutch-Belgian Fortis, (HBOS) Halifax Bank of Scotland and the list is increasing.
But what does it mean for businesses and jobs? The Interbank credit that plays the role of liquidity lifeline for banks, have come to a near halt, because no body knows who is going down next and this credit crunch has trickled down to all businesses. Car industries have been particularly hard hit Recent reports show that car sales in both US and Europe have declined drastically and firms like Chrysler, Volvo, Land Rover and Hyundai have cut sales forecast and jobs. Medium and small businesses are finding it harder to borrow money. No credit means difficulty in paying for raw materials, bills and wages. End of the day it means loss of hundreds of thousands ofjobs.
Governments in US and Europe are now realising that they cannot control the financial system that has grown to a much complex one thanks to innovative people in the financial sector. What is urgently needed now is a complete overhaul of the financial system, putting newer sets of regulations in place, restructuring of rating agencies, and closer surveillance of institu
tions involved in financing.
Does this mean capitalism is coming to an end? Not really. Capitalism has survived one great depression, two world wars, and the threat of being wiped out by communism, in die past two hundred
years. This time too it will survive, but it will take a great deal of change.
The writer is a faculty member at the University of Development Alternative and may be contacted at siddique0110@yahoo com.