The Wall Street.

Wall Street's acid test
Is this the financial apocalypse the world has been dreading since the subprime crisis first hit the global economy more than a year ago? Or is there more to come? That’s the question uppermost on most minds as nothing the US administration does, including the once-unthinkable nationalisation of two big financial institutions, Fannie Mae and Freddie Mac, seems able to stem the slide. If only we could be sure this is indeed apocalypse then maybe we could hope the worst is behind us and expect things to improve. Unfortunately the world has no such luxury — instead there is mind-numbing uncertainty about how many more financial giants may finally go down (and drag economies down with them) as the crisis unravels. Monday’s announcements by Lehman Brothers Holdings, once the bluest of investment banks, that it would file for Chapter 11 bankruptcy protection, and by Bank of America that it had agreed to buy Merrill Lynch in an all-stock deal worth $50 billion only add to the sense of foreboding. It remains to be seen whether the sale of Merrill and the controlled demise of Lehman will be enough to finally turn the tide in the financial crisis that has crippled Wall Street. Reports that American International Group, (AIG) the largest US insurer by assets and Washington Mutual, the largest S&L institution are also seeking Fed support suggest it might not. There is also the danger that the winding down of the 158-year-old investment bank could expose other banks to losses on Lehman’s assets, risking more bank failures even as the Federal Deposit Insurance Corporation exhausts its reserves, raising the spectre of a repeat of the savings and loan meltdown. The only difference is that this time the rest of the world is hitched on to the US economy in a way that was not the case earlier. Inevitably the ripple effects are being felt in markets round the world. The sensex dropped more than 5% in the first 15 minutes of trading (the market finally closed 470 points down at 13,531) and the rupee fell to 46.08 as US financial woes added to fear psychosis created by bomb attacks in the Capital on Saturday. Fortunately many Asian markets were closed, else the carnage might have been much worse. How events will finally pan out is hard to predict but they are bound to hit the broader US economy and the world, including India, pretty hard.
Rescue act
On Tuesday the Reserve Bank of India joined the global rescue act mounted by central banks across the world. Unlike the US Fed which is in the ignominious position of having to bail out one financial institution after another, the latest being insurance giant AIG, RBI’s rescue act was far less drastic. It is aimed at addressing liquidity fears. Thus banks in need of funds will be allowed to borrow more from the RBI, if necessary by holding less than the mandated 25% of deposits that banks need to hold in approved (primarily government) securities, or SLR (statutory liquidity ratio). Banks will also be given temporary access to additional funds through a second LAF (liquidity adjustment facility) auction. At the same time, in a bid to check downward pressure on the rupee that ended Tuesday at 46.93 to the dollar, it assured market players it would ensure adequate supply of dollars. Its move to raise the interest ceiling on non-resident deposits, both rupee and dollar-denominated is of a piece with this since higher rates will increase inflows from non-residents. On paper, its multi-pronged attack has the right touch, aimed at calming frazzled nerves without going overboard. But whether it will have to be followed up with more aggressive steps (a cut in interest rates a la the People’s Bank of China) remains to be seen. Much will depend on whether the US government’s bid to contain the ongoing financial tsunami succeeds. The decision to shore up AIG by agreeing to lend up to $85 billion in emergency funds in return for a stake of 79.9% and effective control of the world’s largest insurer is a marked departure from the hands-off approach to Sunday’s collapse of Lehman Bros. But then the US administration had no choice. Whether this will reduce ‘already significant levels of financial market fragility’ and ward off ‘materially weaker US economic performance’ remains to be seen. The Fed is clearly hopeful, which is why it held the Fed funds rate (indicative overnight interbank rate) unchanged at 2% in its meeting on Tuesday. Unfortunately, it has been wrong-footed before. For the moment, then, the RBI will have to wait and watch.