Saturday, October 27, 2007

The Bail Out Morality

It was nearly one month ago when Northern Rock Bank (If you English Premier League lover, you must be familiar with that bank because it is the main sponsor of the Newcastle United), the fifth largest mortgage bank in UK announced its financial difficulty, due to squeezing on credit market. Then, the problem became more complicated because many depositors queued in front of every Northern's branch, pumping their money out. "Something happened rare in such rich country." said the Economist, when they commentating those rush. Nearly GBP 2 billion was withdrawn in only a short-time. They exactly needed to be bailed out. At first, the Bank of England (BoE) rejected to help the Bank because there were Depository-Insurance program and monitoring also regulating-bank activities which are not the part of their jobs. UK Banking system is quite different with the system exists in Indonesia. Regulating and Monitoring banking system are not the part of BoE jobs. Those are Financial Services Authority main jobs. So, basically, the Bank of England may reject to help the Bank. But suddenly, only several days after Bank of England announced to reject, Mervyn King, the number one man in BoE, revised the BoE's decision which had been made before. Then many people saw that BoE had lost its credibility. Not because revising its decision, but questioning the morality of helping the Bank with very aggressive and risky funding model.



A day after BoE’s decision to, finally, guarantee all of the Northern Rock depositors. Another important event happened in US, something that Wall Street had been expecting. This was the Fed's move to cut its rate, not only 25 basis points but 50! The market reacted very cheerful. Surging Dow Jones Industrial Average by 2.51 %, the highest one-day-jump since April 2003. Suddenly, brokers, bankers, and investors in the Street were gleeful like children who got their dreaming Christmas-gift before the date. The main reason to cut the rate because the Fed thought that the current financial turbulence caused by sub prime mortgage crisis started to drag down the US economy. The credit-market-crunch made company very difficult to raise debt with favorable yield, and threatened many investment banks and mortgage lenders with bankruptcy. The Fed has already bailed out Wall Street. But, many people saw those action deteriorated the Fed's credibility pursuing Inflation Targeting policy, because Inflation is still becoming a main menace for US economy, amid Oil Price surge to above US$ 80 per barrel. An online survey performed by European Wall Street Journal summarized the result which questioning the morality in cutting the interest rate. Helping the mortgage player from the problem was caused by their greedy action.


Yes. The main cause of current financial turbulence simply because greedy and cupidity of sub prime mortgage players. Started from the sub prime mortgage lender and bank which financing risky sub prime mortgage loan with money market fund, simply for the sake of higher interest rate differential than financing through long-term fund. Don't forget also the role of the investor (mainly hedge funds) who takes the risk with buying those money-market securities but purely did not understand the things that had already been bought, because of their complexity. And last but not least, the role of rating agency which used faulty model to rate the securities, but without realizing and still issuing AAA-rating. It’s the same with the faulty role of auditor during the dot-com burst in this earlier decade. The greedy lender, combining with blind-risk taker investor and faulty rating agency, has finally produced a cupidity economic bubble. What a perfect combination right? And now, after the bubble burst, all of the economies have to pay their cost. This such of things did not only happen once. We have already experienced these things several times in our economic history, although in different patterns and appearances. The capital-market crush in 1987; the Asian Crisis in 1997; the Long Term Capital Management bailed out because Russian default in 1998; the dot-com bubble burst in 2001; and sub prime mortgage crisis. Why such things always repeat? Because all of those evils know that their greedy action will be bailed out by central bank, monetary authority, tax payers and the whole economy. Too big to fail. A Moral Hazard.

(Septian)

7 comments:

Berly said...

Check these two insightful articles

http://economist.com/finance/displaystory.cfm?story_id=9957947

http://www.nytimes.com/2007/10/26/opinion/26krugman.html

Letjes said...

James Grant said “Capitalism without financial failure is not capitalism, it’s a kind of socialism for the rich”. see my first post in this blog. Krisis Subprime Mortgage: The Wizards of Complexity

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