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The financial markets are melting down fast. Last week alone, some US$2.4 trillion was wiped out of the Dow Jones. For the past year the losses have totalled US$8.4 trillion. The credit crunch is hurting all financial institutions. Investors do not believe that the US authorities and other authorities in Europe and Asia could respond quickly enough with adequate measures to stem the crisis. The financial conditions are still far from reaching the bottom.

For the first time since the Great Depression, the US government would be buying stakes in financial institutions so that they can become healthy again and provide credit. US officials are revising the US$700 billion rescue package originally designed only to buy out the bad debts from financial institutions. Now they also want to inject capital into the banks, which are losing their capital due to the rapid deterioration of asset quality. British authorities have also done the same thing. They have created a £50-billion package to bail out the troubled banks. The money would be used to nationalise some banks if necessary.

The problem of the financial institutions is not that of liquidity alone but of the threat of insolvency. The two are different. Liquidity shortage can be resolved through giving financial institutions short-term liquidity to roll over and move on. But if the financial institutions face insolvency, they will never become healthy again even if they get the liquidity because there is more debt than assets. Officials would be at risk of throwing good money after bad money.

In the 1997-1998 crisis, several Asian governments committed that mistake of throwing good money after bad money because they could not differentiate between financial institutions that were facing liquidity problem and those that were facing insolvency. The crisis happened so fast, like a tsunami, that they had neither the time nor the manpower to probe the books of all the financial institutions. Liquidity problems, if allowed to drag on, would eventually plunge the financial institutions into insolvency because they will not be able to meet their financial obligations with their counter-parties or clients.

Moreover, low interest rate is no answer to financial institution insolvency. Last week the US Federal Reserve cut its policy rate sharply from 2 to 1.5 per cent, while other global central banks in Europe and Asia and Australia were doing the same thing. Apart from cutting the rates, they also injected massive liquidity into the financial system to avert the crunch because the financial institutions no longer lend money to each other. The central banks are acting as lenders of last resort.

In spite of the lower interest rates, which help the financial institutions to lower their carrying costs, the insolvency problem won't go away. Insolvency can only be solved by debt restructuring and capital injection into the financial institutions, which have to write off the bad debts from their books.

The Paulson Package will produce results if it is set down to work by simultaneously buying out the bad debts from the financial institutions and at the same time giving them fresh capital. But before that, officials will need to write down the capital in tandem with the debt write-off of the financial institutions first. Shareholders have to pay the price for the lending mistake. New management might need to be brought in. Naturally enough, the shareholders will resist capital write-down; the management would try to hang on to their jobs and bonuses.

But Henry Paulson, the treasury secretary, indicated that the government would only buy the preferred stocks that do not have voting rights because it would not want to get involved in the management. He has been urging authorities from other countries, mainly Europe, to embark on a similar financial rescue package to stem the global financial crisis. The UK authorities have responded more timely by not only planning to buy stakes in troubled banks but also guaranteeing bank deposits to pre-empt a bank run. Other European countries have also offered deposit guarantees. But the crisis is most acute in Iceland, when the government took over the country's three largest banks last week.

But Europe is not the same as the US. In the US, the Federal Reserve has acted quickly as a safety net for the financial system. Its measures apply to all the financial institutions in that country. But in Europe, the European Central Bank (ECB) has found itself in an awkward position to deal with the troubled financial institutions. How the ECB sets the priorities in helping the financial institutions in the member countries will become a major problem. The crisis is hitting Europe.

Asia so far has been spared the wrath because its financial institutions have small exposure to the US debt problem. But it will soon get the flu. The global credit crunch will eventually hurt all the countries in this era of global capitalism. If the US slips into deep recession, it will pull other countries downward with it. The financial institutions will find that their good assets turn bad quickly. Corporate earnings will fall. Exporters from Asia will get hurt as they cannot find the buyers. That's why the global financial markets have been reacting with panic over the past week over the systemic collapse of the financial systems.

The authorities have to work quickly to stem the crisis through concerted efforts to avert the meltdown. If they do not work quickly and efficiently enough, the whole world will slip into recession or depression that will take years to recover.