On the Verge of Collapse Can the State Save Banks?

With a drastic intervention in the economy and hundreds of millions of dollars to buy up bad debt, the US government is attempting to prevent further bank failures. But the risk of a meltdown of the financial markets, with drastic consequences for the global economy, has not yet been averted.


Editor's Note: The following article has been provided for background purposes. The story went to press for the Monday issue of SPIEGEL prior to the announcement by the United States government of the scope of its $700 billion bailout to rescue the country's ailing financial sector.

Wall Street Traders (last Monday): The global economy has not come this close to the brink of disaster in decades.

Wall Street Traders (last Monday): The global economy has not come this close to the brink of disaster in decades.

If only everyone were as understanding as James Peck, or as empathetic and benignly smiling. It is Tuesday of last week, shortly after 5 p.m., and Judge Peck is sitting in courtroom 601 in New York Bankruptcy Court in Battery Park, at the southern tip of Manhattan.

Peck straightens his robe, puts on a friendly and conciliatory facial expression and listens attentively. Shai Waisman, an attorney, is standing in front of the judge, presenting his client's case. That client is Lehman Brothers, the fourth-largest investment bank in the United States, founded 158 years ago by the sons of a Bavarian cattle dealer. And bankrupt for the last 30 hours.

Stock market losses and liquidity problems, followed by the previous weekend's hectic meetings to address the current crisis -- all known facts, says the attorney, who insists that there was, unfortunately, no other alternative in the end.

Overnight, one of the most venerable firms on Wall Street became case number 08-13555 in the United States Bankruptcy Court, Southern District of New York.

"It was the perfect storm, Your Honor," says Waisman. The judge folds his hands together and nods sympathetically, looking like a pastor at a funeral.

The overcrowded courtroom is filled with something bordering on a sense of relief -- relief over the fact that at least the ailing patient can finally be put of his misery.

Lawyers and bankers are crowded into the public sections of the courtroom and the hallway outside. Shock is still plainly visible on the faces of many. The demise of the House of Lehman is being negotiated before their very eyes, the biggest corporate bankruptcy in US history. This in itself is already an unprecedented drama in international economic history.

But at the historic epicenter of the Lehman crisis, on the floor of the New York Stock Exchange only three blocks from the bankruptcy court, this is no time to ponder the past.

Traders there have long since embarked on their hunt for the next victims. They are everything but understanding. In fact, they are the polar opposite of Judge Peck.

By Monday morning, Merrill Lynch had disappeared from the scene -- taken over. And by that evening it was Lehman's turn -- bankrupt. On Tuesday, insurance giant AIG was done for -- nationalized, because no one was willing to assume its billions in risks in the derivatives business. By midweek other financial institutions, in Europe and Australia, had met with similar fates. On Thursday it was time for the great hunt on Morgan Stanley, one of the last two major investment banks still standing. The other one is Goldman Sachs.

It was important for "reason to return to the markets," said Morgan Stanley's finance chief, Colm Kelleher. "The world is not coming to an end here," New York Mayor Michael Bloomberg said, and US President George W. Bush sought to reassure Americans that the US economy was generally in good shape.

Grapic: The ECB's cash injections

Grapic: The ECB's cash injections

In fact, the world was able to breathe something of a sigh of relief when the markets closed in New York at 4 p.m. on Friday. A big crash had not occurred, and the widespread sense of relief was even enough to drive the markets up again -- by about three percent in New York and more than five percent in Frankfurt. Some bank stocks even posted double-digit gains, with Deutsche Bank soaring by more than 20 percent at times and Switzerland's UBS by as much as 30 percent.

What a week it was. The global economy has not come this close to the brink of disaster in decades. It was a week of central banks repeatedly injecting billions into the system, of hectic rescue programs by the US government and of desperate talks to get to the bottom of the problem by the remaining bank CEOs. Nothing seemed capable of stopping the plunging exchanges, as fears of a collapse in the financial markets grew from one day to the next. Nothing like this had happened since 1929, when the global economic crisis, the Great Depression, shocked the world.

By Thursday, the Dow Jones Industrial Average had fallen by more than 900 points, before finally recovering somewhat at week's end. In Frankfurt, gains made on the DAX since the fall of 2006 were at times reversed. Russia even suspended trading on its stock exchanges. About $2 trillion (€1.4 trillion) in market value was wiped out in the space of four days. For a time, it looked as if the global flow of capital were about to come to a standstill. The global economic system seemed to be on the verge of paralysis.

And then the markets returned to positive territory. At first it was nothing but rumors, and then rumor became certainty. The American government was intervening, setting up a rescue fund for all of the bad loans that had sent the banks reeling in the first place.

It is one of the biggest interventions into a capitalist economy in history, an act of desperation and an audacious experiment alike. Can the US government truly prevent the collapse of the financial markets with taxpayers' money? On the other hand, does it have any other choice?


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