Federal Reserve & Interest Rates

At one time the largest bank in the world by market value, Ciitgroup saw it’s stock plunge over 60% last week and was in danger of collapse before the Federal Reserve intervened on Sunday.  To put it in perspective, Citigorup’s maket value had fallen to below $21 billion on Friday, which is less than what JP Morgan paid to purchase Bear Stearns back in April, at the same time it has over $2 trillion in assets making it twice as large as AIG. 

As part of the agreement, Treasury and the Federal Deposit Insurance Corporation will provide protection against the possibility of unusually large losses on an asset pool of approximately $306 billion of loans and securities backed by residential and commercial real estate and other such assets, which will remain on Citigroup’s balance sheet. As a fee for this arrangement, Citigroup will issue preferred shares to the Treasury and FDIC. In addition and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.

In order to prevent an even worse occurence of what happened to markets after Lehman Brothers collapse, the Fed agreed to take on the risk of 90% of their debt.  An additional $20 billion from TARP funds will also be used to increase the governments investment in the bank to over 7%.

When considering companies in the ”too big” to fail category, Citigroup was the biggest in the banking system.  The Fed had no choice but to step in and in doing so, it opens the taxpayers up to even more liability.

They won’t be the last bank to need assistance either, while they were the biggest, there are hundreds of banks on the FDIC’s troubled banks list.  I think people are finally beginning to realize how colosally expensive this whole mess is going to become in the end.

The Fed’s will likely lower rates to at least 0.5% after it’s next meeting but will that be enough to restore confidence to credit markets?  And now it looks as if Congress is beginning to question the Fed’s actions in accumulating risk to the taxpayer. 

The Fed has already pledged trillions in liquidity to the banking system but no matter what they do, holes keep springing up.  As things stand now, it appears as if the Fed has no real control over the situation and are left to react as best they can.

Fed chairman Ben Bernanke will have a familiar face to work with when the next administration takes office.  President-elect Barack Obama announced earlier today that the President of the New York Fed, Timothy Geithner, will replace Henry Paulson as the next Secretary of the Treasury.

The selection of Geithner was met with approval on Wall Street as stocks rallied initially before retreating once again at the close of the session.  Since Geithner is already involved with dealing with the current financial mess,  it should make for a much smoother transition than if an outsider was chosen.

Along with dictating how to spend the second half of the $700 rescue package, he will have to work closely with Bernanke in correcting what looks to be a long economic downturn.  We can also expect a flurry of  fiscal policy moves at the turn of the year and it looks as if a new stimulus package will be first on the agenda.   

He will also be responsible for the leading the charge to revamp the regulatory structure of the financial service industry.  It will also be interesting to see how the relationship between government and business continues to develop. 

With the government having an increasing say in how businesses are being run, one wonders if they will go back to the hands off approach once the financial storm passes.  The growing problem of the national debt will also be a major concern as this years record budget deficit may only be the beginning of more to come.

All in all, I don’t think Paulson will mind too much when he relinquishes his mantle in just over a month.

The Producer Price Index numbers(PPI) released today by the Department of Labor showed that prices for finished goods fell by 2.8% in the month of October.  The rapid decline in energy prices since July caused the biggest one month decline in the PPI ever.

The index for finished energy goods moved down 12.8 percent in October following a 2.9-percent decline in September.  Gasoline prices dropped 24.9 percent after falling 0.5 percent a month earlier.  The indexes for liquefied petroleum gas, diesel fuel, and residential electric power also decreased more than in the prior month. 

Prices for asphalt and finished lubricants turned down in October.  By contrast, partially offsetting the faster rate of decline in finished energy goods prices, the index for residential natural gas moved down 5.9 percent compared with an 8.2-percent decline in September.  Prices for home heating oil also fell less than in the previous month.

It’s been a roller coaster ride for oil since last fall, prices began to rise steadily, surpassing the $100 threshold at the beginning of the year and reaching a peak in mid-July close to the $150 mark.  However, oil’s fall from it’s lofty heights has been even faster than it’s meteoric rise.

For nearly a year much of the world was concerned over skyrocketing energy and food prices and the inflationary pressures it placed on other sectors.  Now the opposite is true as economies begin to shrink across the globe.

While many people are welcoming the lower gas prices once again, the sharp fall in prices alludes to a growing problem the economy is facing, falling demand.  The major concerns going into next year will be deflation and the steadily rising unemployment rate.

Many industries are facing an uncertain period where their very survival could be at stake.  The auto industry never really fared too well even in good economic times.  In the current climate, it faces bankruptcy which will mean the loss of millions of jobs. 

There are also conflicts on how best use the second half of the $700 billion rescue package.  The Treasury has put a band aid on the financial system for the time being but the list of troubled areas keeps growing.

One of the fist acts of the new administration will likely be the passage of a new stimulus package which some are estimating will be over half a trillion dollars.  Whether it will be enough to spur demand remains to be seen.