The Crisis is Far from Over

Before anything else, a lesson (I don’t know the author) to illustrate the current financial crisis in the USA:

“Mr. Bill has a bar and decides that he wants to sell cachaça* on credit to his loyal customers, all of whom are drunks, and almost all of whom are unemployed.

Because he decides to sell on credit, he can slightly raise the price of a shot of cachaça (the difference is the interest that is paid on the credit).

The manager of Mr. Bill’s bank, a daring administrator with an MBA, decides that the debts on the bar’s books constitute, after all, an active receivable, and begins to advance money to the establishment, having the drunks’ words as a guarantee.

About six executives from banks, further down the line, back the said receivables from the bank, and transform them into CDB, CDO, CCTV, ITU, UFO, SOS or whatever other financial acronym that nobody can really define.

These additional financial instruments leverage the capital markets and lead to structured operations of derivatives in the Brazilian Mercantile and Futures Exchange, the initial backing of which no one is aware of (the credit books of Mr. Bill).

These derivatives are negotiated as if they were serious titles, with strong real guarantees, on the markets of 73 countries.

Until someone who finds out that the drunks at the bar don’t have the money to pay, and Mr. Bill’s bar goes out of business. And the whole thread unwinds.”

The $700 billion package released by the US government over the weekend is a desperate measure to try to stave off the current financial crisis.

In practice, the Bush administration asked permission from Congress to raise the federal debt of $10.6 trillion to $11.3 trillion. The difference ($700 billion) will be used to guarantee the toxic assets (backed by “Mr. Bill’s books”) created in the financial dance.

The plan sent to the Congress is barely three pages long. This is on purpose, with the goal of giving ample liberty to the Treasury Secretary, the ex-head of the bank Goldman Sachs, Henry Paulson, to take other steps that he deems necessary as the process unfolds.

One of the points that will generate a lot of controversy is the fact that the project sees that the Treasury will not be legally responsible (even if the Judiciary reviews their decisions) if something goes wrong in some of the operations that will be carried out.

It is indicative of the style that has marked George W. Bush’s tenure since the beginning: lots of power and little accountability.

If approved as proposed, the package will create a totally anachronistic situation. Paulson will have super powers to manage the chaos that could require months to resolve–even though on January 20, 2009 the USA will have a new president who could replace him immediately.

On Sunday, Paulson was quick to declare that the plan will also be valid for foreign banks whose subsidiaries are caught in the mess of the American market (something that was not expected initially). The declaration aims to stimulate the Europeans to create similar packages in their backyards, amplifying the chances of a quick recuperation to the credit system. But Germany and the United Kingdom have already discarded the option of bailing out their institutions with larger debts.

The roller coaster of the markets last week, with consecutive double digit devaluations (something completely unheard of), gives a good idea of how lost everyone continues to be during this crisis, which is still far from its end.

The emergency package and the mountain of $700 billion are impressive and will have a tranquilizing effect, at least.

But they also signal what is coming to the US: more failures and a trillion dollar debt that will have to be paid by an economy which is indebted, undercapitalized and completely addicted to credit and financing—which are now in short supply.

*Brazilian distilled alcoholic beverage