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In the times of such crisis, the broader principles are many a times forgotten. Also the proximity of US elections makes these actions to be in the light of tremendous amount of political pressure as to do something and not appear as passive. So under these
circumstances, we can assume that an unfettered market is not the best option and some regulation is necessary to avoid such major crisis arising in the future.

The combined revenues of the big five of Wall Street, i.e., Freddie Mac, Fannie Mae, AIG, Merrill Lynch and Lehmann Brothers, added to $ 322 Billion in the year 2007. Compare it with the fact that GDP of 185 countries, including those of fairly developed countries such as Denmark and Greece, are less than those figures. These firms were so large that it was widely believed that they are unsusceptible to any kind of collapse. Things started going sour towards the end of 2006. But it was only during the last quarter of 2007 that the effect was largely felt with almost all these firms except Lehmann brothers posting losses. This can be characterized as "Privatization of Profits and Nationalization of Losses". American tax-payers were already engaged in a wide debate regarding the misuse of public money to the tune of $ 182 Billion when this issue has arisen where the government is using more than a trillion dollars to bail-out some of America's largest financial giants.

Was this bail-out really necessary and that to by using public money? And what are the problems associated with this kind of action? The answer to the former is "yes" to a large extent.

Consider the case of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Both were offsprings of federal government. Fannie Mae was started in 1938 as a government agency before it became a publically traded company in 1968. Freddie Mac was started in 1970 to provide competition to Fannie Mae. Till recently, they accounted for $ 6 Trillion of mortgage securities. To make the mortgage based securities more attractive, both these firms provided further guarantees that if the home-owner is unable to pay, the firm would pay up. When Fannie was a government agency, this kind of a guarantee was backed by the federal government. So investors by and large believed that as government had created these entities, and thus, would certainly bail-out in case of a crisis. This implicit backing made these securities appear much safer.

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* Contributed by: -
Madhav Sharma had been a Marine Engineer by profession while Sumit Singh had been a Software Engineer before they joined Ist Year Full-Time MBA at NMIMS, Mumbai.
Article posted on October 11, 2008.