WASHINGTON, November 13 – The US government has abandoned plans to buy up the toxic mortgage assets at the heart of the global financial crisis, a reversal that helped send ailing world markets spiralling even lower.
Investor sentiment took another hit as Germany on Thursday announced its economy, Europe\’s biggest, had fallen into recession in the third quarter. Britain said the previous say that it was likely to go into a recession.
Dropping the centrepiece of a 700 billion dollar bailout plan, US Treasury Secretary Henry Paulson said Wednesday the money would be better spent on cash injections for struggling banks and help to shore up consumer credit markets.
Paulson, a Wall Street veteran struggling to put the brakes on the worst financial meltdown in decades, said the crisis had deepened since the controversial rescue plan was approved by the US Congress in early October.
"The facts changed and the situation worsened," he said.
The plan to purchase the bad assets that triggered the current crisis was at the heart of the bailout, and many analysts questioned the abrupt about-face, which triggered another massive sell-off on world stock markets.
The Dow Jones Industrial Average shed 4.7 percent after the announcement, and the gloom spilled over into Asia. Hong Kong shares plunged 6.6 by midday Thursday, while Tokyo lost 5.25 percent.
"It is shocking to see the US government deciding not to use any of the 700 billion dollars on buying mortgage-related assets," said Dariusz Kowalczyk at CFC Seymour in Hong Kong.
"Declining house prices and falling values of mortgage-related securities are the primary reason for the current crisis," he said.
There was more bad news as Germany said it was now in recession, with the economy contracting 0.5 percent in the third quarter following 0.4 percent decline in the second quarter.
Recession is generally defined as two consecutive quarters of negative growth. Britain said Wednesday it was likely in a recession, as economies around the world have been hit by the global slowdown.
The crisis is rooted in the so-called subprime loans in the United States — mortgages to buy houses and other forms of credit extended to underqualified consumers with less than solid credit histories.
The loans were often repackaged and sold to banks and investors around the world. As the economy slowed and house prices declined, defaults on those loans mounted, sending shock waves through the global financial system.
Paulson\’s original plan was for the US government to buy up the bad debts, allowing cash-strapped banks to again make the consumer loans that are essential to driving the economy.
But on Wednesday he said the money earmarked to buy those debts would be better spent injecting cash directly into struggling banks and shoring up the market for consumer debt such as from credit cards and car loans.
"This market, which is vital for lending and growth, has for all practical purposes ground to a halt," he said.
An unusual joint statement by bank regulators, Paulson\’s Treasury Department and the US Federal Reserve issued on Wednesday urged banks to keep lending in the face of the downturn, saying it was needed for a sound economy.
"If underwriting standards tighten excessively or banking organisations retreat from making sound credit decisions, the current market conditions may be exacerbated, leading to slower growth and potential damage to the economy as well," it said.
How to proceed with the bailout has been complicated by the pending transition of power in the United States from President George W. Bush to his newly-elected successor Barack Obama.
Obama and Bush have disagreed on aid for US automakers, who are struggling. General Motors says it needs immediate cash to stay afloat, and any collapse by GM, Chrysler or Ford would send another shudder through world markets.
The financial meltdown has already been felt across the globe, from powerhouses like Japan and Germany to developing economies like China and India, and share prices have been battered.
Japan\’s stock market has lost about 45 percent this year. The Dow Jones has shed 37 percent, and London\’s FTSE-100 has dropped 35 percent.
Chinese Premier Wen Jiabao said the effect of the worldwide slowdown on his country was "much worse than many had expected." China announced an almost 600 billion dollar stimulus package this week to shore up the economy.
Bush will host the first of several planned global summits on Friday and Saturday to address the crisis — this time with leaders of the Group of 20 major rich and developing countries. Obama is not attending.
At the meeting Japan will offer to lend up to about 100 billion dollars to the International Monetary Fund to help boost loans to emerging countries hit by the financial crisis, local media reports said.