Weekly Focus
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Crisis measures taken to new level
Fri, Sep 19 2008, 14:38 GMT
by Danske Research Team
It has been a hectic week with a series of ad hoc measures taken by the US authorities aimed at securing stability in the financial system. Attempt to save the financial system has now been taken to another level, with the Treasury and the Fed apparently now targeting the entire financial system by setting up a fund to take over bad assets from financial companies' balance sheets and creating a federal insur-ance scheme for investors in money market mutual funds. The authorities are now targeting the root of the problems in the financial system and the move could potentially mark a turning point in the financial crisis, as the uncertainty over potential future losses on "toxic" bank assets will be mark-edly reduced.
By setting up a fund to take over toxic assets, fear of addi-tional bankruptcies among the major banks would diminish. Market prices for many of these toxic assets have been de-pressed by forced selling, which stems from funds having to liquidate assets to raise capital or because the funds simply collapsed and had to sell all their assets. Falling share prices have also made it more difficult for the banks to raise capital and have led to downgrades. The downgrades im-plied that even more capital had to be raised while at the same time making it even more difficult to do so. This vi-cious circle has been a threat to the whole financial system. We will continue to see losses related to the overall eco-nomic downturn, but fears of a total financial meltdown should diminish if these measures pass through Congress. This would obviously be positive for risky assets such as credit and equities, while bonds would suffer as the flight to safety winds down.
The intervention raises moral hazard issues, as it implies a bail out on a grander scale in which the taxpayers take over the risk of the toxic assets. However, if current prices on these assets are excessively depressed because of panic selling the measure could also turn out to be profitable.
Published on Fri, Sep 19 2008, 14:42 GMT
Archive
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