US bailout plan sparks share falls
The US government has announced a $700 billion rescue package that will see taxpayers' money used to buy-up 'bad debt' from the banks.
The scheme, which is currently being considered by Congress, will allow the government to buy-up the debt held by banks and reduce their exposure to these assets. However, the plan has sparked more turmoil on global stockmarkets, with share prices in Asia and Europe falling sharply.
This is because there is a still a question mark over how the rescue plan can be applied and how acquiring the bad debt could put taxpayers' money at risk.
Simon Denham, managing director of Capital Spreads, says it is unclear whether the bailout will work or not.
"If it does work we can either look forward to several years of very low growth and falling margins (possibly deflation) or, if liquidity does return to the banking sector quickly, the possibility that a $700 billion injection (from the US alone) sparks a huge money supply spike, and thus a big inflationary bubble," he warns. "Neither of these is exactly good for equities.
"If the whole project fails then, unfortunately, more banks will go under and at some point the governments of the Western world will be forced into wholesale nationalisation, to protect the assets of the rest of the economy."
Meanwhile, Wall Street's Morgan Stanley and Goldman Sachs have been forced to change their status to holding banks and accept customers' deposits in a bid to maintain their independence.
The two firms, the last independent investment banks on Wall Street, have spent the last week fighting for survival following recent heavy falls in their share prices and the bankruptcy of rival Lehman Brothers.
Their trouble stems from investors being nervous about financial institutions that have exposure to risky sub-prime mortgages and pulling out their money. This has made it difficult for them to raise capital to shore up their balance sheets and have forced the banks to look elsewhere for funding.
Now that the two banks have changed their status they have access to the Federal Reserve's financial support.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
A person (or business) unable to pay the debts it owes creditors can either volunteer or be forced into bankruptcy – a legal proceeding where an insolvent person can be relieved of their financial obligations – but loses control over their bank accounts. Bankruptcy is not a soft option. Although it may wipe the financial slate clean, it is extremely harmful to a person’s credit rating (it will stay on your credit record for six years) and will adversely affect your future dealings with financial institutions. Bankruptcy costs £600 paid upfront.