Guarantees that could not be honored thrust the world financial system into its worst crisis since the Great Depression. Will a guarantee by the U.S. government finally restore confidence in the American financial system?
Only a week after Treasury Secretary Henry M. Paulson Jr. said that the government bailouts had stabilized the most important financial institutions, plunging stock prices forced the government to step in again, both to make another direct investment and to guarantee that losses would be contained from $306 billion in possibly toxic assets on Citigroup’s balance sheet.
The move sent stock prices soaring Monday, with financial stocks leading the way. But those gains did not come close to erasing last week’s losses, and left open the possibility that a renewed sense of concern about the safety of other banks could force still more bailouts in coming weeks.
One lesson may be that it is perilous for the government to even hint that it thinks it is through bailing. That can renew fear about banks, driving down share prices and forcing the government to do the opposite of what it had intended. Because the government has a printing press, it need never be short of dollars. That fact makes this guarantee much more credible than the ones, from bond insurers and other companies, that helped persuade banks and others to take what turned out to be huge risks. Many of those guarantors, it turned out, could not honor their obligations. The government feared financial chaos if there was a string of collapses. Even if Citigroup is the last bailout, the Bush administration, whose rhetoric was perhaps more supportive of free, unhindered markets than was that of any of its predecessors, will leave a trail of socialized risk.
But that trail may not be at an end. The auto companies want billions of dollars in bailouts, and other industries are lining up.
And as the nation’s obligations rise into the trillions of dollars, at some point investors may begin to question whether a government running huge deficits can also credibly promise that the dollar will not lose its value. Such a worry conceivably could push up the very low interest rates the Treasury now pays to borrow from foreign investors to foot an ever-larger rescue bill.
But those are problems for another day. Now the priority is to keep the financial system from collapsing. The problems of recession, constricted lending markets and falling real estate prices will remain even if everyone concludes the big banks are safe.
In the latest bailout, the government injected an additional $20 billion into Citigroup, on top of the $25 billion it invested a few weeks ago. It also said that it would cover 90 percent of the losses on $306 billion in securities after Citigroup absorbed the first $29 billion of losses.
The fact that it was necessary to guarantee so many assets — about a sixth of the $2 trillion in assets that Citigroup reported at the end of September — was another indication of both the complexity and the opacity of many of the securities that were created by financial engineers in the great wave of innovation.