Bush: Couldn't Be Worse

In every financial crisis, people’s expectations play a fundamental role in its intensity and, from my point of view, President Bush made sure to emphasize a sense of panic by presenting the financial rescue package as a question of life or death for the American economy. Taking also into consideration Bush’s urgent meetings with presidential candidates and claims of the chairman of the Federal Reserve, it’s understandable that the market panicked after the $700 billion rescue package was rejected.

Facing the subprime mortgage crisis, the government had three options: a) carry out a selective rescue, b) a general rescue, or c) do nothing and let others assume the losses.

The American government started off with selective rescue measures, later got scared, shared its fears with the investors, and came up with a broad rescue package. In other words, it first chose plan A to immediately abandon it for plan B. This couldn’t have been done any worse, because that same government said that the rescue package was the only option on the table. By presenting the situation this way the government conveyed a message that the crisis was grave. Bush scared the market.

What would have happened if option “c” had been chosen? The losses would have become responsibility of those who have invested in the mortgage market. What Bush tried to accomplish through the famous $700 billion rescue package was a socialization of losses. And the average American would inevitably ask: “Why am I to cover the losses of those who gambled on the financial market?”

We’re witnessing a situation crucial for the future of two approaches that may now impose themselves on the market. One is moral sanction and the other is rescue of those who commit investment errors. In the first case, the investor has the right to make profits, but cannot transfer his losses to others if he’s mistaken. Both profits and losses are privatized. In the second case, profits are privatized and losses are socialized. In this scenario, from my point of view, irresponsible investment decisions are encouraged.

What should be done now? Everything depends on what will happen with the famous rescue package. If it’s not successful even after a face lift, the bad news is that some will have to assume the losses by selling assets at very low prices. The good news is that the Congress would send a message that in the future the 7th Cavalry will not show up to rescue reckless investors who take risks and expect that others will pay for the errors of their rash decisions.

Another good news is that the institutions seem to be working fairly well in the United States, as it was the Republican majority that prevented the passage of the rescue package, among other reasons because it didn’t want to authorize the Treasury Secretary to use $700 billion as he pleases. This may be difficult for us, Argentines, to understand, because we’re used to our Congress approving the superpowers of the Executive.

Another thing to be kept in mind is that falling stock value of corporations that have nothing to do with the financial system doesn’t seem to be caused by their bad results. For example, the falling value of General Motors or IBM stock, to mention just two cases, wouldn’t be a consequence of losses in their balances, but of the necessity of certain investors to sell these stocks to maintain liquidity. In other cases, panicked investors who don’t want to wait, sell stock and sustain losses, which perhaps would not seem like the only option in the future. In other words, who now has liquidity, can buy assets at a bargain.

Another matter to consider, among the infinity of issues in this crisis, are commodity prices. A couple of months ago the world was flooded with suggestions on what to do about rising food prices. Some arguments claimed that investment funds were speculating and buying commodities (among them oil) which made transportation more expensive, affecting in turn commodity prices again. A barrel of oil no longer costs $150; the prices of maize, wheat, and soy have fallen, just to cite a couple of examples. This way, if the commodity prices were artificially high because of “speculations” of fiduciary funds, the problem of the rising food prices would have been solved. Obviously, under this new scenario it is necessary to analyze the possible impacts on fiscal accounts of that bubble which seems to have burst and which brought us so much tail wind over the last five years. If the First World is facing complications, I’d say that around here we should get prepared.