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World economy

The state rides to the rescue

Article published on the 2008-09-19 Latest update 2008-09-19 14:54 TU

A trader at the Philippine Stock exchange(Photo: Reuters)

A trader at the Philippine Stock exchange
(Photo: Reuters)

On Friday, US Treasury Secretary Henry Paulson declared that the state will spend billions of dollars to rescue crisis-hit financial system. President George Bush declared that "significant amounts" of taxpayers' money will be used. That followed massive interventions over the past two weeks to support banks and financial institutions. Does the move signal the end of decades of unfettered free-market capitalism?

The US government is looking at several measures such as that used in the savings and loan crisis of the 1980s and 1990s. Then the government created the Resolution Trust Corp, which bought up assets from failed banks and eventually resold them, to help end the crisis.

"As we've said for some time, the root cause of the stress in the capital markets is the real estate correction," said Treasury Secretary Hank Paulson, following Thursday's meeting with Federal Reserve chief Ben Bernanke and top lawmakers.

The crisis, which began a year ago but deepened in recent weeks, was set off by so-called subprime mortgages from US banks - loans to home-buyers who in many cases were unable to make the payments.

The defaults drove down US house prices and decreased available cash and credit. And financial institutions, which had bought many of the loans as part of their investment instruments, found themselves exposed to the bad debts.

Because of the importance of the US economy on a world scale, the crisis has had an international effect.

The crisis has led to the mergers or collapse this week of several Wall Street giants, including Bear Stearns, Merrill Lynch and Lehman Brothers. Now Morgan Stanley may be threatened, while in the UK, Lloyds bank has bought HBOS.

The US's 85-billion-dollar rescue of insurance giant AIG and its bailing out of investment bank Merrill Lynch are controversial because they have used taxpayers' money to save private companies. The plan currently under discussion is also likely to use public funds.

The US authorities were highly critical of Asian government intervention in Asia's financial markets crisis in the 1990s. 

Some commentators see the US moves as a sharp reversal of a doctrinaire faith in the market.

Luxembourg's Prime Minister Jean-Claude Juncker, who heads the finance group of the Eurozone, on Friday claimed that the English-speaking world is now behaving "in the way that we would have always chosen to tackle this phenomenon".

"Now they are rediscovering that one always needs governments," he said.

"We will not agree to make up for the shortcomings of faulty regulation," said French Prime Minister François Fillon on Thursday.

"US financial companies have a serious responsibility for what can only be described as capitalism that's gone off the rails," he added. "Europe expects the American authorities to measure up to their responsibilities."

But Liem Hoang-Ngoc, a researcher at the Economic Centre of the Sorbonne, believes that the transformation is not that dramatic.

"The American state has never really relinquished its economic policing role," he says. "In the past we've seen the federal government put aside its ideology to support banks and companies in difficulty. It doesn't mean the end of liberalism, this intervention is, above all, pragmatic."

"The banks are no longer giving credit and they're especially afraid of lending from one private bank to another, afraid that the bank will suddenly default," says Francine Quentin of RFI's French service.

To encourage banks to accept the risk, the interest rate that they charge each other has soared. That has reduced the amount of money that can be used for the daily functionning of the economy.

The central banks are responding to the situation of scarce credit by injecting billions of dollars into the system. This emergency measure can only be temporary while awaiting the renewal of confidence, says Quentin.

French Economy Minister Christine Lagarde says the bankrupty of Lehman Brothers should have limited impact in France due to the weak exposure of French banks.

In the past year, the crisis has cost French banks 18 billion euros.  However, the French banking system has been relatively insulated. This is mainly because there are few small independent banks and its large financial groups are highly diversified.

Since Lehman Brothers went bankrupt, several French institutions have published the results of their debt commitments with the American bank.

These amount to almost four billion euros between BNP Paribas, Société Générale and the Crédit Agricole and the Franco-Belgian group Dexia, and to a lesser degree, Natixis, La Banque Populaire and Crédit Mutuel.