Financial Crisis: America rises to the occasion as storm heads towards brittle Europe
By Ambrose Evans-Pritchard Telegraph
Last Updated: 9:35pm BST 21/09/2008
An almighty crash has been averted, very narrowly. There is no guarantee that the revolutionary actions of the US government will prevent a full-fledged global slump, but at least we now have a fighting chance.
By taking the colossal wreckage of the credit bubble onto its own books in a $700bn (£382bn) taxpayer sink, Washington has forestalled a run on the world banking system, and may hopefully have saved the viable core of modern capitalism.
Hank Paulson's "Super Sink" is the "game changer" we have all been waiting for in this interminable crisis. It puts a floor under the toxic debt that is bleeding the banking system to death, and ends the downward spiral of CDOs, CLOs, HELOCs, and such instruments of leveraged excess that lie at root of the credit terror. No doubt the Fed, the Treasury, and Congress have made a string of mistakes but they are now rising to the occasion - the reflexes of a wounded but still formidable superpower. The US has shown time and again that it has the institutions and flair to pull itself out of disaster.
We will find out soon enough whether the rest of the world can respond with such dispatch as the hurricane smashes into them. As of today, the core risk is no longer in the US. It has rotated to the weaker and more brittle polities of Europe, Latin America, and Asia - especially China.
Europe has embedded paralysis in its treaty law. Maastricht prohibits a Keynesian blitz. Budget deficits above 3pc of GDP are not allowed until an EU country is already in dire straits, and even then approval requires a committee vote by 27 states. So Ireland, Italy and France must now tighten fiscal policy into the downturn. There is no EU Treasury to back the euro, and therefore no Euro-Paulson with the powers and legitimacy to take sweeping steps in an emergency. By extension, there is no clear-cut lender of last resort either. Each country is on its own, yet none have the instruments of monetary policy to carry out a Paulson-type rescue with credible punch.
The European Central Bank stands aloof with Teutonic severity, as hawkish as the old Bundesbank - or the Reichsbank in 1931. It too is a prisoner of a rigid treaty mandate. There was a mad Wagnerian feel to its July rate rise. We now know that Euroland was already slipping into recession when it acted. Do the hawks mean to unleash Götterdämmerung on the peoples of Spain, Ireland, Italy, Portugal, and Greece, with all the dangers that must accompany a disintegration of EMU?
It is incessantly repeated - often by people with an animus against the US - that "dead-beat America" cannot afford these serial bail-outs. Perhaps, but compared with whom, and to what?
The US government debt (owed to the public, using the IMF measure) is just 48pc of GDP, one of the lowest of the G7 industrial powers. This compares with 57pc for Germany, 94pc for Japan, and 100pc for Italy. After the Second World War, the US debt touched 120pc of GDP. As the Habsburgs liked to say, today's drama is desperate but not serious.
Note too that the US is the only power (bar India) with a birth rate high enough to meet its future pension costs. Japan is already shrinking; China faces the start of workforce implosion within seven years; Russia is a demographic basket case.
Mr Paulson's Super Sink is modelled on the Resolution Trust Corporation, which cleaned up the Savings & Loan mess in the early 1990s. The RTC added no debt and made a profit in the end.
The Paulson plan will not prevent a deep US recession, but as the spearhead of a policy crafted to keep Americans in their homes, it will slow the avalanche of foreclosures and change the profile of future mortgage defaults. House prices may not, after all, drop by 34pc as now priced by the futures market. That is a reprieve for hundreds of regional lenders on death row.
Call it moral hazard if you want, but as President Bush said: "There will be ample opportunity to debate the origins of this problem. Now is the time to solve it."
The game was up in any case on Wednesday when yields on three-month Treasury notes fell to zero in a panic flight to safety, and investors began mass withdrawals from America's $3.5 trillion money market funds.
After the trauma of the last week - the Lehman bankruptcy, the state seizure of AIG, the Morgan Stanley scare, the heart attack in the market for credit derivatives, and the monoline debacle at AMBAC - it should be clear to everybody that rigorous debt liquidation would be viciously destructive.
The world has seen nothing like this (in peacetime) since President Franklin Roosevelt shut the banking system and confiscated gold in March 1933, though his words were more memorable than last week's Bushisms.
"The rulers of the exchange of mankind's goods have failed, through their own stubbornness and their own incompetence. They know only the rules of a generation of self-seekers.
"The money changers have fled from their high seats in the temple of our civilisation. We may now restore that temple to the ancient truths," he told the nation.
Will we hear such language before long from President Obama, addressing the most radical House and Senate in living memory? Probably. From moral hazard to moral rebirth.