In the fall of 2008, a little more than a year after the Bank for International Settlements (a Switzerland-based organization that fosters cooperation between central banks) warned that “years of loose monetary policy have fuelled a giant credit bubble, leaving us vulnerable to another 1930s slump,” the combustive concoction of free market fundamentalism, corporate-dominated globalization, stagnant wages, growing inequality, greed, excessive leverage, and financial innovations such as securitization finally exploded.
Financial market conditions in the OECD countries sunk to their lowest levels in more than half a century, and the U.S. government made its most dramatic interventions in financial markets since the 1930s. The Federal Reserve and the Treasury nationalized the country’s two mortgage giants, Fannie Mae and Freddie Mac; bailed out AIG, the world’s largest insurance company; and, in effect, extended government deposit insurance to $3.4 trillion in money market funds.
Then, in the largest government rescue operation in history, Treasury Secretary Henry Paulson announced a plan to buy up to $700 billion of toxic securities from troubled banks. Incredibly, Paulson’s original plan, only three typed pages, would have given Wall Street almost unrestrained access to public revenues at little cost. The Treasury plan was rejected by the House of Representatives and subsequently modified by the Senate. The version approved by Congress promises to make a larger share of any subsequent profits into public revenues.
The landscape of American finance has radically changed. The independent investment bank, a Wall Street animal that relied on high leverage, is now extinct. Lehman Brothers has gone bust, Bear Stearns and Merrill Lynch have been swallowed by commercial banks, and Goldman Sachs and Morgan Stanley have become commercial banks themselves. The “shadow banking system”—the securities dealers, hedge funds, and other non-bank financial institutions that defined deregulated American finance—is unraveling as I write.
The credit shock is reverberating across the world. In Europe, economies are unraveling after ten years of growth financed by borrowing. For much of the past year the emerging world watched the Western financial hurricane from afar. Their own banks held few of the mortgage-based assets that undid the rich world’s financial firms. Commodity exporters were thriving, thanks to high prices for raw materials. Even as talk mounted of the rich world suffering its worst financial collapse since the Great Depression, emerging economies seemed a long way from the center of the storm.
No longer. As foreign capital has fled and confidence evaporated, the emerging world’s stock markets have plummeted (in some cases losing half their value) and its currencies have tumbled. The seizing up of the credit market caused havoc, as foreign banks abruptly stopped lending and stepped back from the m...
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