National Treasury Building, Washington DC
Can Anything Be Done to Stop the Panic?
By Dr. Satya Dutta
The stock sell-off continues with no end in sight despite actions taken by the Federal Reserve, the U.S.
Treasury, the Group of Seven governments, and their central banks to stabilize the global financial
markets. Since the crisis started, the Dow Jones Industrial Average has lost almost $7 trillion of its value.
Some analysts call it a panic selling. But can it be stopped? The answer is yes, but it may not be easy or
quick. We have experienced panics and stock market crashes before in 1812, 1837, 1857, 1873, 1903,
1907, 1914, 1917, 1929, 1973-74, 1987, and 1998; the dot-com bust and market slump of 2000-2001;
and of course the current slide. Steep declines in stock markets happen quite often, and some are worse
than others, but the markets have always, eventually, recovered.
Currently, the U.S. government is implementing a two-pronged policy to resolve the financial crisis and
bring about normalcy in the stock market. First, the Federal Reserve is aggressively lending money to
banks and other financial entities (details of this were discussed in the previous newsletter). The logic is
that by flooding the banking system with additional reserves, it can get the banks to relend the money to
the rest of the economy. While providing liquidity is essential, it may not be sufficient, as the banks can sit
on the borrowed money (by not lending) or not borrow at all. When the Federal Open Market Committee
(the decision-making body of the Federal Reserve) meets this week, the Federal Reserve is expected to
lower its short-term lending rate again by at least 25 basis points to 1.25%.
In the second approach of this policy, the U.S. Treasury will invest directly into selected banks on a large
scale. The logic behind this approach is that since these banks are holding toxic mortgage-baked
securities that they cannot sell, simply lending banks more money would not solve the problem. What
needs to be done is to restore their positive net worth so that they can lend freely. To that end, the U.S.
Treasury has shifted its priority away from buying those toxic mortgage-backed securities and toward
pumping up to $250 billion in new capital into large U.S. banks in return for temporary ownership of
banks. The British government has also taken steps in the same direction, as it has offered to buy up to
$88 billion worth of preferred stocks of Britain’s largest banks. Many economists believe that this
recapitalization may well mark the beginning of the end of the crisis.
Dr. Satya Dutta is a Professor of Economics at the College for Financial Planning in Denver, Colorado.
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