US $700 bn Bailout package rejected


US Bailout package rejected

The ‘toxic’ Wall Street $700 bn emergency rescue package was rejected by the House of Representatives on Monday as few members were willing to shell out tax payers’ money for the unpopular measure only 5 weeks before election.

The turmoil that started in US has began to spread to Europe as well bringing down old-fashioned commercial banks. The week started with the rescue of three banks in Europe followed by the distressed sale of big U.S. lender Wachovia to Citigroup. Many banks across the world got nationalized as “capitalism took a sabbatical”.

  • In the UK, one of the biggest mortgage lenders B&B has been nationalised. In all, four of the top 10 mortgage lenders have now been nationalised or required an emergency rescue since mid-07.
  • The governments of Belgium, the Netherlands and Luxembourg jointly took 49% stake in Fortis Bank, a major Benelux bank.
  • The German government and a consortium of banks provided €35 bn to a large German Bank that is specialized on real estate and government funding.
  • In Denmark, trading in the shares of a small bank was stopped on Friday. In total, six minor Danish banks have now been sold/merged or bailed out by the state so far in recent months.

Implication

The bailout was designed in part to get financial institutions to start lending again by removing the toxic mortgage-backed securities and other holdings that lenders fear could cause borrowers to default. If credit markets continue to seize, the impact on businesses and consumers could be widespread. Access to loans would be reduced, crimping spending and investment. Economists said the credit crunch could lead to increased layoffs in the U.S. and prompt a hefty rate cut from the Federal Reserve. Also this increases the concerns that the U.S. may face a prolonged recession if the legislation isn’t revived.

Market Reaction

Fear gripped all the markets across the globe from New Zealand to US, Latam as the rescue package failed.

  • The Dow, which was desperately hoping for a rescue, plummeted over 600 points within minutes. The DJIA plunged 778 points for its biggest point drop ever as $1.2 trillion in market value was erased from American equities
  • European shares slumped to a three-and-a-half year closing low on Monday, with banks facing the maximum brunt.
  • Stocks in Asia dropped roughly 4% on Tuesday on opening with China’s two biggest banks opening more than 8% lower.
  • In Latin America, Sao Paulo’s Ibovespa stock index closed down at 9.4%, the worst one-day slump since falling 10% on Jan. 14, 1999. Brazil’s currency, the real, closed down 6.4% against the U.S. dollar, reaching its lowest level since Sept. 5, 2007.
  • Buenos Aires’ Merval index meanwhile dropped 8.7% while Mexico’s main index slipped 6.4%. Chile’s Ipsa index closed down 5.5% and Colombia’s IGBC index dipped 2.4%.
  • Investors panicked looking for safe investment avenues. Commodity prices fell. Oil prices dropped nearly 10% after the announcement reaching $95.82/bbl. Gold rose 5% reaching a two-month high of $920 on Monday but was still below a lifetime high of $1,030.80 struck in March.

The US bailout package of $700 along with loans to AIG and Bear Stearns adds up to around 6% of GDP, well above the 3.7% of the savings-and-loan bail-out in the late 1980s and early 1990s. This would have been still less than the average cost (16%) of resolving banking crises around the world in the past three decades.

Bottomline:

The immediate impact of this bailout measures are:
Increased risk aversion will cause foreign investors to keep selling assets in emerging economies. This will impact our market sentiment negatively. INR will be under pressure. Liquidity will continue to be tight (so high call rates) as RBI intervenes in forex by selling USD along with advance tax outflow, month end borrowing, and increased demand for Navaratri.

The month of September had been a nightmare and someone had aptly said “wake me up when September ends”. But it looks like it will take some more time to get things back on track.

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