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Clarification to This Article
This article quoted World Bank President Robert B. Zoellick as saying the world financial system may have reached a "tipping point." Zoellick was referring to the effects of global turmoil on developing countries.
TIPPING POINT?

Unfolding Worldwide Turmoil Could Reverse Years of Prosperity

Traders work at the Brazilian Mercantile and Futures Exchange in Sao Paulo. Brazilian stocks plunged the most in a decade as commodity producers dropped, and trading was halted twice because of the decline.
Traders work at the Brazilian Mercantile and Futures Exchange in Sao Paulo. Brazilian stocks plunged the most in a decade as commodity producers dropped, and trading was halted twice because of the decline. (By Marcos Issa -- Bloomberg News)

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By David Cho and Binyamin Appelbaum
Washington Post Staff Writers
Tuesday, October 7, 2008

What went wrong?

Last week, the nation's political leaders said the financial system would collapse unless they passed a $700 billion rescue package for Wall Street. On Monday, the first day of trading after the plan passed, the financial system continued to melt down anyway.

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Here's why: The plan developed by Treasury Secretary Henry M. Paulson Jr. to buy troubled U.S. mortgage assets might not start for another month. And, despite its huge price tag, it already seems paltry compared with the scale of the rapidly evolving global crisis.

"People are realizing that the Paulson plan is not going to be nearly enough. It's not because the plan is ill-conceived. It looks like it's the right thing to do, but the problem is just growing astronomically," said Martin Evans, a professor of finance and economics at Georgetown University.

The bailout plan is focused on buttressing U.S. financial institutions. But it was global markets that plunged yesterday, as investors sold off commodities in Brazil, currency in Mexico, bank stocks in Russia and the short-term debt of the state of California.

Robert B. Zoellick, president of the World Bank, said the global financial system may have reached a "tipping point" -- the moment when a crisis cascades into a full-blown meltdown and becomes extremely difficult for governments to contain.

The mushrooming problems "will trigger business failures and possibly banking emergencies. Some countries will slip toward balance-of-payment crises," he said yesterday, speaking at the Peterson Institute for International Economics.

The crisis threatens to reverse years of prosperity that financed the economic growth in developed and emerging countries through a global financial system that made credit widely available. Banks and governments were able to borrow money on an unprecedented scale by selling debt in new kinds of packages, allowing even the least creditworthy consumers to borrow and spend.

China exported goods and then loaned the money back to the United States by buying those new debt packages. The story was similar for Russia, which exported massive amounts of energy to Europe, and for Brazil, which exported commodities including orange juice and sugar. All used the massive inflows of borrowed money from the developed world to fuel economic expansions and stock market bubbles.

Yesterday, trading on the major stock exchanges in Russia and Brazil was halted after prices crashed. China's major indexes fell about 5 percent. The bubbles appear to be bursting in rapid succession.

Faced with these developments, the markets have not been in a mood to cheer the passage of the Paulson rescue package. At one point yesterday, the Dow Jones industrial average had fallen nearly 800 points, more than 7 percent. It ended the day off 3.6 percent, below 10,000 for the first time since 2004.

"Quite frankly, what the market is looking for is some kind of coordinated action from central banks around the world." said Kathy Lien, director of currency research at GFT Forex. The Paulson plan, she added, is like a "Band-Aid for a problem that stretches way beyond the banking system now."


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