Wall Street bail-out: What next?

Tuesday, 30 September 2008 12:00 AM

Last night the US House of Representatives shocked the world and voted down the White House's $700 billion bail out.

Rebels from both the Democrats and the Republicans stood against the bill - despite the backing of Bush, Obama and McCain - with arm-twisting on the floor of the house coming to no end.

In the post-mortem Republicans blamed the speaker Nancy Pelosi for making a partisan speech influencing Democrats, while the Republicans that crossed the floor did not like infringements on free markets from a 'socialist' bill.

Under all the rhetoric, Congressmen and women face re-election and - in the words that have become de rigueur - Main Street is unconvinced about plans to save Wall Street.

Traders on Wall Street, meanwhile, stopped their mania of selling to watch the lawmakers and were left aghast.

The Dow Jones Industrial Average saw its biggest points drop of all time - but not the biggest percentage fall - losing 777 points and closing at 10,365.45. Over £1 trillion of losses were recorded, and all they wanted was $700 billion.

So what is the next step forward?

Last night Asia was rocked with the Nikkei dropping 4.12 per cent, but the Hang Seng made up initial lost ground and closed up 0.76 per cent.

Europe today somehow is holding firm - but it is interesting to see it is still the banks that are hurting.

Since the beginning of 2007, the banks have underperformed compared to the FTSE 100 by 32 per cent - meaning in a falling market investments in banks fell a third more than the whole index. Banks are still falling today.

Even a month ago the mood was that the worst was over for the banks. No-one is brave enough to say we are through the worst today.

So what will happen to London? The mood seems down and the FTSE could well fall further before it claws its way back up.

Back in New York, President Bush today expressed his disappointment but said there would be a new law.

"The reality is we are in an urgent situation.. the economic damage will be painful and lasting."

It seems the markets are buoyed again in the short term as the US government will eventual bridge the divide and start to buy up the 'toxic' mortgage-backed assets.

"We have a choice between action and the real prospect of economic hardship for millions of Americans. Congress must act," Bush said.

"Our economy is depending on decisive action."

Mr Bush may promise that the taxpayer could turn a profit on the deal to buy mortgage assets as he suggests their value may rise in value as the market recovers.

It is certain he will not be in office to find out, and it is possible neither will his successor.

US lawmakers now have to put aside Treasury secretary Hank Paulson's $700 billion dream and a new deal has to be hammered out.

Legislators have to come up with a deal they can prove to their electorate will aid them directly. Plenty of ideas are being bandied about such as bringing Fannie Mae and Freddie Mac in some way, or banks to take on more of the risk of the falling value of the mortgage-backed assets.

A deal will be made, that is almost certain, but this is just the beginning of the story.

The crisis - from the bottom and misselling of mortgage to people who could not afford them by people only interested in making sales to the repackaging and reselling many times over of this debt - is centred on the free market not working.

In theory, in the free market we all have information about the investments and goods we throw our cash at. But without sufficient checks to ensure this, no-one had any idea about what they were buying.

Also humans don't seem to function like rational consumers in the economics text books that define the free market. Every day on the markets you see traders acting like herd animals following whatever investments seem to be rising or falling - without checking why.

Did the short-sellers take advantage of this? Very probably, but the value of banks were going down because of the uncertainty over their value and the lack of transparency in the system - when a free market should make all things see-through.

Banks are being rescued or left to collapse because of this uncertainty and opacity.

A new era - at least for the US - will see greater regulation as the country takes on not so free capitalism and tries to create certainty.

Daniel Barnes

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