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US government bailout – is this the start of the recovery?

by Scott Bicheno on 19 September 2008, 22:33

Tags: US Treasury

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Light at the end of the tunnel?

The US Treasury Secretary, Hank Paulson, today announced broad measures to restore the flow of credit in the US financial system by removing the "illiquid assets" - mostly bad mortgage debts - that he said "are weighing down our financial institutions and threatening our economy."

This amounts to a massive taxpayer purchase of these bad debts in order to "restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity." The extent of the bailout will amount to hundreds of billions of dollars.

The good news is that this move has been well received by global markets. At time of writing, the FTSE 100 had posted a record one day gain of 431.30 (8.84%). The French Cac 40 was up 9.27 percent and the German Dax was up 5.56 percent. Banks were the biggest gainers in all these markets. The rest of the world's markets were pretty much all significantly up on the news.

So the question is: is this the start of a recovery? There have been many other brief upswings in the past year, but this is the most significant move by the US government yet. The root cause of the current financial crisis is a declining spiral of bad debt coupled with poor availability of credit to help manage it.

The US Treasury seems to have decided that enough is enough

The US Treasury seems to have decided that enough is enough and it's time to sort the situation out. By offering an almost unlimited amount of public money to clearing these bad debts from the system, it is looking to draw a very expensive line under the astoundingly poor business practice of the financial sector and give it a chance to recover and learn from its mistakes.

If it's successful and does cause the end of the Credit Crunch, then everyone will start lending to each other again and vital liquidity will be restored to the global financial system. Because this seems to be an open-ended promise to do what it takes to sort things out, there are reasonable grounds for assuming it will succeed, at least to some extent.