Is it over? Or is this the lull before the next storm?
There were stomach-churning moments last week when the global financial system seemed dangerously close to utter collapse. The decision by European governments over the past few days to collectively put in $2.5 trillion to shore up the continental financial sector has clearly calmed investors. The US, too, is moving towards the European solution of using public money to bolster bank capital rather than use it to buy toxic assets. The US government now says it will spend $250 billion to buy stakes in troubled banks in that country.
Meanwhile, central banks are ready to pour money to thaw the frozen markets for short-term money. The US Federal Reserve has said it will provide unlimited amounts of dollar funding to the European Central Bank, Bank of England and the Swiss National Bank.
Wall Street on Monday saw its most spectacular rally since 1929. Asian and European markets were doing well when this editorial was written. India, too, has bounced off its lows. Fear is receding— thankfully.
But this is a time to let out a sigh of relief rather than a whoop of joy. A meltdown seems to have been averted but the battle ahead will be a long one.
The roots of this financial crisis lie in the housing bubble that has burst in the US and Europe. Housing prices continue to fall in these regions, so the losses made by direct lenders and buyers of mortgage securities will rise as economies stumble along. There is also growing agreement that the US, Europe and Japan are very close to what could be a long recession. The gargantuan bills for pulling the Western financial sector back from the brink will leave governments with less money to prop up demand in hard times. And these bills will eventually have to be paid by taxpayers, either immediately through higher taxes or later through higher inflation.
Undoubtedly, all credit is due to the governments and central banks that averted what looked like a sure case of disaster.
But that is not the end of the story. Bursting bubbles are inevitably painful. And this one too will be.
Have we seen the worst of the financial crisis—or are there more shocks ahead? Write to firstname.lastname@example.org