A loss of trust

Our view: Fearful investors could prolong slump

July 15, 2008

Every Christmas, millions of Americans get a close look at the pain and hysteria of a run on a bank when George Bailey contemplates suicide after panicked customers demand their money from his tiny savings and loan in the Frank Capra classic It's a Wonderful Life. In the movie, George's friends and neighbors raise the money to pay depositors, and the bank is saved. Rules established to insure deposits and limit risks have made recent, real-life runs less painful.

Now, investors have a different reason to be afraid. When banks like IndyMac - a California-based giant taken over by federal regulators last weekend after panicked customers withdrew $1.3 billion - are declared insolvent, most depositors will get their money back, but rescuers will struggle to deal with a growing portfolio of troubled loans fed by a decline in home real estate values.

The real estate bust is threatening to sharply limit bank mortgage lending, and that's the real danger. The extent of that threat became apparent Sunday when the Federal Reserve stepped forward with a promise of an unlimited line of credit for Fannie Mae and Freddie Mac, two federally chartered lending giants holding or insuring half of the nation's $13 trillion in mortgages that faced a potential financial crisis as investors sold their stock.

Investors fear the freewheeling business practices of recent years that made fortunes for banking and investment company executives will leave them holding the bag. They've lost faith in the repeated assurances of stability from big financial institutions that have subsequently failed. Now, they'll run to sell company stock on any rumor, true or false. That loss of confidence is sure to lead to more bank failures - some unnecessary - and prolong the agony of the current real estate slump.

It's a painful lesson about the importance of ethical values in a free market economy. Investors need to be able to believe corporate financial reports and trust the judgment and character of business leaders - just as the residents of fictional Bedford Falls trusted George Bailey. Congress is promising new lending rules, and better-managed companies should eventually lead to a recovery. But millions are likely to lose their homes to foreclosure before trust is regained.

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