WE haven't seen drama like this since the Great Depression of the 1930s.

Two weeks ago, the US financial system was one step from a meltdown. Now, the US government looks ready to save the day by bailing out the banks.

Are they deserving? In a way, it doesn't matter. This is no time for moral judgments, as I will explain.

In the 1920s, my grandfather was a farmer and owned a store that sold seed and animal feed to farmers in the US state of Indiana.

When the Great Depression hit, he said: 'I am glad the big-shot bankers will finally get what they deserve. This depression will bring them down a notch or two.'

Yup, that was what happened. Many banks and companies went broke. A few executives even jumped out their office windows and committed suicide.

But when a bank goes out of business, its services do too.

One year later, my grandfather was also broke. He had lost the store after failing to find a bank loan to finance its inventory.

For the next 10 years, he scratched out a living by growing corn with the help of his mule and a plough.

Fast forward 75 years and we come to the story of Mr Dick Fuld, 62, chairman of Lehman Brothers investment bank. He may be the proudest CEO in this entire crisis.

Just before his company declared bankruptcy, he turned down a US$5 billion ($7 billion) buyout offer from the Korea Development Bank.

It wanted a 25 per cent share in Lehman, which would have valued the company at US$20 billion. Mr Fuld said it was too little.

Bad move. Today, Lehman is being sold off in pieces at fire-sale prices.

S'pore feels pain too

Lehman's pain and suffering has reached all the way to Singapore. Its collapse means investors here will lose all or part of their $500 million invested in Lehman's Minibonds plus an unknown amount in DBS' High Notes 5.

In contrast, Mr Fuld didn't do too badly. He pulled in US$500 million from salary and stock options over his 14-year tenure at Lehman.

The biggest mystery may be why Lehman was allowed to fail in the first place. Weeks earlier, the US central bank had saved a smaller investment bank, Bear Stearns. So, why not Lehman?

The big bailout

Piecemeal bailouts are out. The US government's latest plan will assist all banks. Non-banks can also be included by calling themselves a bank. That is what Goldman Sachs and Morgan Stanley did.

The government will buy troubled home loans from banks and then re-sell them in a few years when markets stabilise. It followed a similar plan in the last banking crisis in the 1970's.

The US will pay for it with debt. The US national debt is now US$10 trillion.

While it is a lot, it doesn't need to be repaid. The US can roll over the debt forever.

Only the interest must be paid. It is also expensive and comes to about US$500 billion per year. It is manageable at around 15 per cent of the annual government budget.

The rescue is needed. It reassures depositors who might panic and withdraw their money if they judge a bank's risks to be too high.

Those risks vanish when bad loans are shifted to the government, which is seen as too big to fail.

While the US has avoided a financial meltdown, it may not dodge a recession.

US banks now shy away from risky loans. Credit has dried up. Home prices are low and oil is stuck above US$100 a barrel.

It adds up to a probable slowdown in US and world economies in 2009. But at least there won't be a meltdown.

 Back to Columnists