KEY POINTS:
As is his way, President George W. Bush somehow managed to be upbeat about the near collapse of Bear Stearns, the United States' fifth largest investment bank. "One thing is for certain, we're in challenging times," he said. "But another thing is certain, we've taken strong decisive action." By `we', he was referring to the Federal Reserve, which has gone to startling lengths to not only orchestrate the rescue of Bear Stearns but to infuse the financial system with cash to stop it seizing up. It is a moot point whether the central bank's dramatic interventions have added to the sense of panic but, in reality, there was probably little choice.
The Federal Reserve chairman, Ben Bernanke, is confronted by a sharply contracting global banking system, the development feared most when the first hint of a credit crisis appeared a year ago. The scale of the problem has caused him to abandon long-cherished beliefs, notably that a central bank should base its policies on consistent principles, not ad hoc judgments. This approach led initially to accusations that he was disengaged and slow to act. The contrast with his feverish activity now conveys an unavoidable fear factor. Above all, it confirms Mr Bernanke's bleak view of the US economy, with the ongoing housing market woes and credit market paralysis.
The crisis of confidence crystallised around Bear Stearns, which came close to foundering seemingly overnight as confidence in its operations dissipated. Its Achilles heel was aggressive financing of sub-prime mortgages, which left it exposed when the housing market soured. The bail-out, overseen and aided financially by the Federal Reserve, resulted in Bear Stearns being sold to JPMorgan Chase at a rock-bottom price. That unconventional initiative by the central bank was complemented by an offer to extend direct lending to troubled securities firms for the first time since the 1930s Depression.
Such moves owe far more to pragmatism than free market principles. The Federal Reserve is making light of the moral hazard of bailing out large financial institutions and shielding investors from loss. In normal times, this would be seen as an encouragement for more reckless risk-taking. Now, the Federal Reserve justifies it on the ground that it is better to shield a few investors than make millions suffer by allowing market stress to drag the economy into a deep recession. Perhaps so, but for shibboleths to be abandoned the situation must, indeed, be extremely dangerous.
All this is far from academic to New Zealand. This country is increasingly decoupled from the US, not least in a trading focus on Asia. But it cannot be immune from a sickly US economy or, as a country heavily reliant on overseas borrowing, the credit crisis. Already, there are symptoms. Investment manager ING has been forced to suspend withdrawals from two of its funds because of the credit crunch. They had invested mainly in debt securities. Many of these instruments are complex, and the difficulty of valuing them is an integral part of the current difficulty.
Utterly uncomplicated is the Federal Reserve's other tactic, that of cutting US interest rates. It hopes that lower borrowing costs will stimulate economic activity and stabilise the housing market, the catalyst for the global crisis. This is the conventional way of calming markets and warding off recession. It carries the threat of triggering inflation and further devaluing the dollar, but Mr Bernanke can expect no criticism. Certainly, none will come from President Bush, who says his Administration has "shown the country and the world that the United States is on top of the situation". The world must hope that, for once, he is right.
