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Commentary By Nicole Gelinas

Wall St. Debt Knell

UNCLE Sam is acting not out of cool rationality but out of hot terror.

In defense of the proposed $700 billion at tempt to salvage what's left of the financial-services industry last week, President Bush said that "this is a big price tag because it's a big problem."

Thing is, it's not clear this is a solution. There's no guarantee that even this much cash can buy us out of a systemic financial crisis. Even if it does, we probably face years of necessary financial and economic readjustment.

Consider: In the space of six months, the feds have bailed out bits and pieces of the financial sector, starting with protecting investment bank Bear Stearns' private lenders in March and ending, most recently, with the $85 billion loan to insurance giant AIG.

Yet all the might of the federal government couldn't stop the global markets from rendering their verdict, anyway: The American financial sector was and still is a toxic soup.

Last week, the markets put their final seal on that verdict: Investors large and small, domestic and international started pulling their money in droves out of the last pillar of the private credit markets: the money markets.

Many people and institutions have long treated such funds as "safe" savings accounts, even though they weren't insured by the feds, because they invest in only the highest-quality short-term debt—corporate, bank and government.

But no more. Midweek brought news that two such funds had lost value due to their investment in Lehman Brothers—only the second and third time such a thing had happened in the funds' four-decade history. Another fund had to close up shop because so many investors wanted their money back.

Overall, Americans pulled 5 percent of their assets out of this $3.4 trillion market in one week.

More pullouts would force the funds to sell more of their debt investments, pushing their values down further, causing more losses.

That threatened disaster for a market that provides lifeblood to the economy—namely regular financing for all kinds of entities, from credit-card companies to auto lenders and down to you and me.

Without money markets, the US economy would grind to a halt—and then quickly go backward.

So the White House announced that it would guarantee the value of those funds.

To find a precedent, you have to go back to 1933—when the Hoover administration in its waning days hastily signed a law temporarily guaranteeing bank deposits so that savers would stop fleeing the system. (This later became the permanent FDIC, showing what kind of sea changes we're dealing with here.)

Back then, one congressman said, "The United States today is on the brink of economic and financial chaos." That's just as true today.

The government's action—and the fact that the markets forced it to act—changes everything. The feds capped off the painful end of a long era in which sophisticated banks and ordinary Americans took for granted investing nimbly and pretty much safely (or so they thought!) in lightly regulated debt. Their confidence and the government's hands-off attitude helped make up the backbone of the modern capital markets.

Those markets, the thinking went, didn't have to be heavily regulated or insured, as long as the core banking system - your old, real savings account—was carefully regulated and safe.

The uninsured money markets were the last and most essential part of that backbone to disintegrate over the last 18 months.

First went the business of complex debt securitization—the idea that banks could engineer away risk through structured finance, that they could sell fail-safe "collateralized debt obligations" of things like mortgages and credit-card balances and the like to sophisticated global investors who knew what they were getting into.

Next was the demise of "structured investment vehicles"—bank-related funds that provided much of the demand for that securitized debt. They died when jittery investors stopped funding them last year. When the funding stopped, banks had to take this debt onto their own books; stuck with so many old, bad deals, they lost much of their ability to do new lending. This, too, showed that yet another financial-engineering innovation had turned out to be far riskier than anyone had thought.

Then there were the auction-rate securities markets, through which many government agencies and financial institutions raised money. Many people and institutions had treated auction-rate securities as if they were as safe and easy as cash—but it turned out that wasn't the case, either.

All this culminated in the feds' rescue of the "ultrasafe" money markets—and that was all that was left. Lending on this side of the Atlantic has basically stopped.

Now the feds are trying to restart that everyday lending—and we had all better hope that the guarantee of money-market funds and other government injections into the money system work.


But if it does, what comes next?

The proposed $700 billion rescue package, in which the Treasury hopes to buy up mortgage-backed securities and the like from surviving financial institution, isn't a long-term solution to anything. At best (and at high cost), if the government buys such securities at a premium, it could prevent some big institutions from taking the losses they're due and going bankrupt.

And make no mistake: These are real losses. When a bank lends someone making five figures a half-million-dollar mortgage on a house that's worth maybe $200,000, that loan, in the cold light of day, is worth less than 50 percent on the dollar—far less when you think of the bank's cost of foreclosing on and maintaining the house until it can be resold at a realistic price.

These losses are only a symptom, though. The problem is that the financial sector, a key engine of the US economy and one of our key exports, appears irretrievably broken. It is only operating now because of government intervention so heavy that it borders on nationalization.

The US financial sector, in other words, is now Amtrak.

It's not the end of capitalism; instead, it's capitalism saying that, in its current form, the financial sector doesn't work. Seven hundred billion dollars can't fix that.

This piece originally appeared in New York Post

This piece originally appeared in New York Post