Page last updated at 10:57 GMT, Tuesday, 23 September 2008 11:57 UK

Would a $700bn bail-out end the crisis?

By Anthony Reuben
Business reporter, BBC News

Friday's bounce-back on global stock markets sounded like a sigh of relief at the end of an unprecedented week.

House Financial Services Committee Chairman Rep. Barney Frank
I think we have to recognize the reality that we don't have a choice now of debating whether this is a good or a bad thing
Barney Frank, chairman, House Financial Services Committee

US Treasury Secretary Henry Paulson effectively said that he was sick of dealing with individual banks in trouble and instead was going to bail out the whole system by buying up the toxic debt that is causing all the difficulties.

"This needs to be big enough to make a real difference and get at the heart of the problem," Mr Paulson said.

It is certainly big - there will be $700bn (379bn) available to buy up debt based on mortgages.

Investors seemed to believe on Friday that the measures would, at least in the short-term, provide some much-needed stability.

"If you look at the reaction in the stock, Treasury and (interest-rate) swaps markets, they're all telling you that this is a good thing and that you're taking some of the fear and risks out of the system," said Mike Kagawa from Payden & Rygel in Los Angeles.

All wrong

But then on Monday a touch of political reality entered the equation - how much would the bail-out package change on its way through Congress?

There have been many times in the year-long credit crunch when some people have declared that the worst is over and the recovery is under way, and so far they have all been wrong.

This is like throwing a life-ring to someone who is drowning
Brian Bethune, Global Insight

But there is a broadness about the latest measures that gives a degree of confidence that they could indeed deal with the toxic debt problem.

"It takes away the sword of Damocles hanging over the financial system," says Brian Bethune, chief US financial economist at Global Insight.

"This is like throwing a life-ring to someone who is drowning. The trouble is it's still a proposal and it still has to go through Congress."

No choice

Congressional leaders appear close to allowing the measure to go through, with a few amendments.

"I think we have to recognize the reality that we don't have a choice now of debating whether this is a good or a bad thing," said Barney Frank, chairman of the House Financial Services Committee.

While throwing $700bn at the problem may deal with it in the short term, in the long run there could be problems.

"It's pushing the problems to later - somebody will have to pay and that is the taxpayer," said Frederic Ponzo, managing director of the consultancy Net2S.

The weight on the taxpayer is one of the issues worrying Congress.

Bailing out the financial system may sow the seeds for a future economic and political crisis
Jon Danielsson, London School of Economics

The government plans to buy up mortgage-backed assets at their current discount prices and is hoping that their value will recover in the next few years.

Risk of losses

"By the time we get to 2010 or 2011 the price of these assets should be higher," said Mr Bethune.

"If not they'd have to report losses on the asset purchases so the cost to taxpayers would be high."

Another thing worrying Congress is that bailing out banks that have made bad decisions will encourage them to take even greater risks in the future - the so-called moral hazard problem.

"Bailing out the financial system may sow the seeds for a future economic and political crisis," said Jon Danielsson at London School of Economics.

The other danger is that even if the US banking system is bailed out, there will still be problems elsewhere in the world.

"If you look at the biggest European banks, their central banks do not necessarily have as deep pockets as the Federal Reserve to bail them out," said Mr Ponzo.

There is also still a danger that it will turn out that there is something else toxic in the system that will keep the crisis going, but Jon Danielsson doubts that.

"This removes the biggest chunk of uncertainty in the banking system," he said.

"It is hard to see anything else coming up because there is nothing else out there."

Print Sponsor


RELATED INTERNET LINKS
The BBC is not responsible for the content of external internet sites


FEATURES, VIEWS, ANALYSIS
Has China's housing bubble burst?
How the world's oldest clove tree defied an empire
Why Royal Ballet principal Sergei Polunin quit

BBC navigation

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.

Americas Africa Europe Middle East South Asia Asia Pacific