Causes of the American financial turmoil and its effects on the global economy [Archives:2008/1200/Opinion]

October 20 2008

By: Mahmoud Al-Qassas
Despite the fact that the U.S. House of Representatives approved a financial rescue plan, many economists still hold the view that impacts of the current financial crisis in the U.S. will be broad and deep, and continue for a long time period to come.

Such a rescue plan is based on establishing a fund to purchase deferred debts from financial institutions for a lump sum of $ 700 billion.

The plan is considered the biggest governmental intervention in the stock markets since the very beginning of the economic recession which the whole world experienced between 1929 and 1932. The primary objective of the plan is to provide a necessary liquidity to avoid potential collapse of the American financial system.

To understand inevitable consequences of this crisis, we should first have a quick glance at its real causes. According to Dr. Fuad Shaker, Chairman of Arab Banks Union, the main cause of the crisis is the notable expansion of real estate debts in the American market, which mostly depends on the rising prices of real estate.

But, as the economic growth in the United States declines, prices of real estate decline too.

In the meantime, debtors stopped repaying any debts on them to banks, accompanied by an increasing unemployment rate. Consequently, the banks found that they could not sell its assets to restore loans because the value of such assets have become simply less than the value of loans.

From his side, Ibrahim Al-Badawi, an economic expert at the World Bank, whose viewpoints reflect his personal positions and not those of the World Bank, said that financial institutions purchase securities with the guarantee of real estate debts. He adds that these securities are usually reproduced and resold in the secondary market many times over as long as there are people who buy them. In other words, real estate debts are exchanged in markets without any oversight or control.

It goes without saying that rotation of capital leads to creating new funding opportunities, but it carries great risks, particularly as a great part of these loans come without any guarantees if the real estate prices collapse. This is what has happened on the ground.

In short, the current state of turmoil clarified the weak oversight and control over U.S. stock markets and the enthusiasm of its managers to make interests with the highest levels of risks. As a result, the U.S. government found itself obliged to intervene and then nationalized “Freddie Mac and Fannie May companies”, the two biggest real estate credit institutions in the United States. Afterward, the government forwarded a financial rescue plan.

Different financial management

Fuad Shaker is of the opinion that this turmoil will lead to change in the methodologies the U.S. banks and financial institutions are currently using.

The institutions involved are recommended to impose greater restrictions on the processes of real estate credit, as well as on the process of loan sale between banks as invested assets. They are also recommended to rectify the margin of real estate credit along with changing the value of estate in the market.

According to Shaker, those concerned must question bank managers who concealed facts from depositors. This is a risky matter since it shakes depositors' trust in the banking system.

He also holds the view that the turmoil will lead to establishing a new international frame to organize stock markets in order for the global economy not to become a victim of American problems.

He expects that such a new international monetary system will be based on a greater European and Asian role but smaller American role.

Source:, quoted from BBC Arabic