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Last week the US financial markets went through one of the worst gyrations in their recent history. The mounting home foreclosures, growing inflation and an ever-weakening dollar saw the Federal Reserve taking several unprecedented steps including brokering the bailout and takeover of major investment bank Bear Stearns.
Although there could be a thousand valid reasons to justify the Fed move under the current extraordinary circumstances, it should become a point of introspection for the free market evangelists and give enough food for thought to all those who accuse Middle East sovereign wealth funds and Asian central banks of practicing state capitalism, protectionism and interfering with market mechanisms.
While the sovereign wealth funds are often accused of distorting capital flows and harbouring sinister political ambitions, Asian central banks are blamed for all the woes of global trade by keeping their currencies low through market intervention in an effort to keep their exports competitive. Yet aren't they too defending self interest that lies at the core of modern free enterprise?
In whichever way the Fed and the US administration are going to address it, there is no question that a crisis of historic magnitude is now unfolding. By their own admission, Wall Street's financial wizards see that the United States economy now stands on the brink of an economic breakdown on a scale not seen since the Great Depression.
The measures taken by the Fed so far underscore the fact that Bear Stearns is probably the first in a series of institutional failures looming over the US in the coming weeks and months.
The rate cuts and infusion of liquidity into the system may be interpreted as the Fed's prerogative as the lender of last resort, but the fact that it is assuming responsibility for some $30 billion in illiquid assets held by Bear Stearns, as part of the takeover agreement with JP Morgan Chase, is nothing short of direct intervention in the free market.
The Fed's actions, coming on top of massive infusions of liquidity into the financial markets and an agreement to accept as collateral mortgage-backed assets that are of dubious value mean that the US central bank is potentially agreeing to take onto its balance sheet hundreds of billions of dollars in bad investments, damaging the long-term prospects of the economy and the dollar.
Many analysts believe that the inability of the Fed to resolve the crisis by pumping in more credit stems from the fact that the central problem facing US the financial system is not one of liquidity, but of solvency. And hence the Bear Stearns model of intervention.
A complete collapse of Bear Stearns would have certainly led to a distressed sale of its assets and domino effects across financial markets undermining the balance sheets of other major banks and financial institutions, all of which have made similar investments.
The above argument probably justifies the Fed's recent short-term-fix interventions, but it is time the world realised that the US is actually fast slipping into an era of state-run capitalism while pointing fingers at others for practicing protectionism and politically motivated capital movements.
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