Next up: ‘Mother of all Bank Runs’
Risk of ‘total systemic financial meltdown’ still lies ahead, say economists
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Venkatesan Vembu
1 October 2008
Risk of ‘total systemic financial meltdown’ still lies ahead, say economists
HONG KONG: Even if the $700 billion bailout plan, which was shot down in US Congress on Monday, is eventually passed, it may not be able to avert a total systemic financial meltdown in the US, say economists.
“The longer it takes for a rescue package to take effect, the more severe a US recession will be,” warns Moody’s Economy.com economist Sherman Chan.
In her reckoning, an interest rate cut by the US Federal Reserve Board “is now a must” if market confidence around the globe is to be restored.
“In fact, coordinated central bank action would be a much stronger help.”
Given the growing stress experienced by financial institutions in recent days, interest rate cuts by the major central banks in coming days seem increasingly likely, notes Chan.
But even “massive policy actions”, including the eventual passage of the bailout plan, may not help because “there is ageneralised loss of confidence in financial markets and in financial institutions that no policy action seem to be able to control,” observes economist Nouriel Roubini.
In fact, he reckons, the risk of a “total systemic financial meltdown” may still lie ahead. The strains in financial markets — money markets, credit markets, stock markets and derivative markets — are becoming more severe rather than less, even after the US Treasury made clear its intention to use the “nuclear option”, he adds.
The next step of this panic could be “the mother of all bank runs”, that is, a run on the $1 trillion of cross-border, short-term inter-bank liabilities of the US banking and financial system, since foreign banks are starting to worry about the safety of their liquid exposures to US financial institutions, he points out. In fact, such a “silent, cross-border bank run has already started as foreign banks are worried about the solvency of US banks and are starting to reduce their exposure.”
If this run accelerates, “a total meltdown of the US financial system could occur... We are thus now in a generalised panic mode and back to the risk of a systemic meltdown of the entire financial system.”
US authorities, in his estimation, “seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 basis points reduction in policy rates in all the world’s major economies to show they are starting to seriously recognise and address this rapidly worsening financial crisis.”