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Ambrose Evans-Pritchard: Bailouts better than returning to 1930s

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Wednesday, March 19, 2008

Put a clothes peg on your nose. The moral stench of bailouts for the uber-rich will be sickening. None of us wants to pay a farthing to rescue the bankers and assorted debt pimps who got us into this financial mess, and in doing so exposed our societies to such harm. Most of us would rather relish the delicious moments of Schadenfreude as the bailiff's gavel falls on their Gulfstream IVs.

Yet we must forbear. It was such sentiments that turned the 1930 recession into a slump. "Liquidationists" prevailed: They insisted with Puritan zeal -- or malice -- that speculators should be driven to the wall amid a cathartic purge of the Roaring '20s.

Among them were top bureaucrats at the US Federal Reserve and some of Europe's central banks. The consequence was the Bruning deflation in Germany, ushering in the Nazis. Democracies snapped across half of Europe. If it had not been for the towering figure of Franklin Roosevelt, America might have splintered into a bedlam of Prairie populists, Coughlan fascists, and Huey Long extremism.

We should be thankful that the man now heading the US Federal Reserve -- Ben Bernanke -- spent his early career immersed in the details of that catastrophe. He has written books showing how a credit crunch can set off a vicious downward spiral, and do so with lightning speed. You do not mess around in such circumstances.

The "liquidationists" accuse Mr Bernanke of taking a dangerous gamble with inflation by slashing rates from 5.25 per cent to 2.25 per cent in six months, culminating in a trenchant three-quarter-point cut Tuesday. They accuse him of "moral hazard" for invoking a Depression-era clause permitting the Fed to take on $30 billion of direct credit risk left by the wreckage of the US broker Bear Stearns.

They are right, in a sense. This is probably the start of a massive taxpayers' rescue of the banking system. It stinks. But imagine if Mr Bernanke had listened to such advice as Bear Stearns faced collapse.

It is America's fifth biggest investment bank. It has $13,400 billion of derivative positions, and has underwritten $491 billion in options contracts. Topple this domino at your peril. It risks a chain of cross-defaults through the entire "shadow banking system," that vast untested nexus of paper commitments.

Bear Stearns had a liquidity cushion of $17 billion early last week. It vanished in two days. This was a run on a bank by New York insiders. It would not have stopped there. If the Fed had not taken emergency action on Sunday night, wolf packs would have fallen on Lehman Brothers (even bigger) with equal ferocity this week. The crisis threatened to snowball out of control.

America is not facing "recession as usual." It is in the grip of a property crash. House prices have fallen by 10 per cent so far; Goldman Sachs fears they may fall by 30 per cent in the end. The sub-prime mortgage industry has already disintegrated. Some 241 lenders have gone bust or shut their doors.

The crisis has since spread to prime mortgages. Fannie Mae and Freddie Mac -- the fortress agencies that guarantee 60 per cent of America's $11 trillion mortgage market -- began to crumble last week. Even bodies standing at the top of the credit system are no longer deemed safe. As Barclays Capital put it, this was a "tsunami event."

Or in the words of City veteran David Buik at Cantor Fitzgerald: "No one in living memory has ever seen a banking crisis like this. I am older than God, and the outlook has never looked as bleak."

Any smug assumption that this will remain a local American affair may soon be confounded. The International Monetary Fund has abruptly changed its tune. "Obviously the financial market crisis is now more serious and more global than a week ago," it said on Monday.

Property booms will soon be deflating across the Anglo-Saxon world and the eurozone's Club Med belt. Japan is already on the brink of recession. Debt levels are higher now in most rich countries than they were in 1929. The levels of financial leverage are greater.

As the Bank for International Settlements wrote last year, we are more vulnerable to a 1930s denouement than people realise -- should the authorities botch the response.

Like some other free-market bears, I now find myself in an odd position. For years we castigated the central banks for inflating a reckless credit bubble by holding interest rates too low. Now we have flipped. We are on the other side, defending monetary stimulus, even defending the state takeover of Bear Stearns debt.

No doubt we will have to defend yet more egregious intervention by the state before this is over. We will become temporary socialists.

Too bad. The world is in deep trouble. Purist ideology has become a danger. The "liquidationists" must be countered, and defeated.

When the dust settles, we can revisit the burning question of how we got here. We can try to remember that the time for tough love in monetary policy is at the start of a boom, not the end. We can administer condign punishment in Mayfair and Westchester County later for what has happened.

If it is any comfort to hard-liners, Bear Stearns shareholders have just suffered a 99 per cent haircut. Our own Joe Lewis has a lost a billion dollars. Satisfied?

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