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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.
Unfolding Worldwide Turmoil Could Reverse Years of Prosperity

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.

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."

Treasury officials say that ramping up the rescue package will take time, and that they are working as fast as possible.

Yesterday, the department released the contracting rules for the asset managers they expect to hire to oversee its rescue program, requiring interested parties to apply by tomorrow. The Treasury also named Neel Kashkari as the interim assistant secretary of the Treasury for financial stability to oversee the rescue program until January, when the next administration takes office.

Despite the mammoth bailout, Zoellick and other leaders are now urging central banks from the leading economies to devise a coordinated response.

They don't have a lot of time.

It's been nearly three weeks since Federal Reserve Chairman Ben S. Bernanke warned lawmakers that the nation was at risk of a full-blown meltdown.

Since then, the same problems have afflicted Europe. Governments have bailed out five large financial firms, including two this weekend, triggering fears of additional bank collapses in Europe.

Hypo Real Estate, a German real estate lender, is collapsing under the weight of its own bad loans, forcing the German government and leading banks to announce Sunday that they would lend the company up to $68 billion.

The rescue follows the nationalization of one of England's largest real estate lenders, Bradford & Bingley. Iceland also rescued one of its largest banks, Glitnir. And several European countries were forced to invest billions of dollars in Fortis, one of the largest banks on the Continent, in an ultimately unsuccessful effort to stave off its collapse. Fortis, too, has now been nationalized.

With confidence in banks basically shattered, governments increasingly have been forced to issue explicit guarantees that bank deposits will remain safe.

Ireland last week guaranteed all deposits and liabilities, totaling about $540 billion, at six domestic banks. The pledge included branches of the six banks outside of Ireland, and excluded branches of other banks in Ireland, raising concerns that deposits would now flow from rivals into the coffers of the six government-protected banks as investors flee to safety.

Germany promised Sunday to guarantee all private savings accounts, which hold at least $800 billion. Denmark yesterday announced that it would guarantee all deposits, as well.

The economies of Ireland and Denmark have officially fallen into recession. Investors meanwhile are worried that Pakistan and Argentina might default on their debts. In India, the average interest on loans between banks jumped above 11 percent, reflecting a breakdown of trust.

The bailout has not even thawed critical segments of the U.S. credit markets.

U.S. corporations sold $1.25 billion in bonds last week, marking the sharpest drop in sales volume since 1999, according to Bloomberg. Short-term commercial borrowing fell to $1.6 trillion, down 9 percent in the past two weeks, almost entirely because of a massive decline in borrowing by financial companies that cannot find lenders at any price.

September saw the worst monthly losses in the history of the hedge-fund industry. Investor withdrawals could lead to the collapse of major funds, triggering further sell-offs and exacerbating the financial crisis.

Investors are also increasingly concerned that more U.S. banks will fail before the Treasury can launch the rescue program. Shares of National City, a regional bank based in Cleveland, fell 27 percent yesterday.

Bank of America said its third-quarter profit fell 68 percent, largely because of losses on mortgage loans and credit cards. The company reduced the dividend on its widely held shares by half and said it would try to raise another $10 billion from investors. Its shares were down about 7 percent, to $32.22.

"These are the most difficult times for financial institutions that I have experienced in my 39 years in banking," chief executive Kenneth D. Lewis said in a conference call.

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