Federal Reserve & Interest Rates

There is still the second half of the $700 billion bank rescue plan remaining to be spent but there are a number of disagreements on how to spend it.  The first half was used to re-capitalize banks in exchange for preferred stock and some feel that should be the way to go for the second half of TARP as well.

Of those in the re-capitalization camp, some feel that they should be getting common stock instead with voting rights that would give the government more say in the day to day operations.  However, then the government would share the same risks that current shareholders face and then there is the question of paying out dividends when the government still needs to be repaid.

Another group wants to use the second half of Tarp to prop up the housing market, which was how this whole mess started.  They want to use the money to help forestall foreclosures and to stimulate consumer lending, namely mortgage creation, in order to increase demand for home purchases.

Although between $50 billion and $100 billion of Obama’s new stimulus package is earmarked for the housing market, many feel that is an inadequate amount.  Although the House approved the stimulus package, the Senate has yet to vote and substantial changes could be made to it before all is said and done.

Another problem though, is that the banking system is still filled with toxic assets that is weighing down on credit creation.  There are some that are pushing for the creation of a “bad bank”, a government run agency that would buy up all the toxic assets freeing up the banking system.

Unfortunately these toxic assets are hard to value and some estimates have their total value ranging from between $2 trillion to as much as $4 trillion.  If the government were to undertake that plan their risk would rise substantially and the potential losses to taxpayers could be staggering.

There are already rumblings that another round of TARP is needed and that what is left of the initial TARP isn’t enough to cope with all the leaks the financial system currently has.

Congress moved quickly to pass Barack Obama’s $819 billion economic stimulus plan, little more than a week after he took office.  The package was passed 244-188 with no Republicans voting for the measure, twelve Democrats also voted against it.

The lack of bipartisan support is troubling and the bill will move on to the Senate where significant changes are likely to be made.  The Republicans hold enough seats in the Senate that they are able to put pressure on the Democrats and can delay a vote with procedural obstacles.

As the plan stands now, it contains about $275 billion in tax cuts and approximately $550 billion in direct fiscal spending by the government.   The Republicans are pushing for more tax cuts and less spending, House Democrats rejected a proposal that would have lowered the two lowest marginal tax rates by 5% each. 

The stimulus plan would create between 1 million and 3 million jobs during the next few years.  The economy lost approximately 2.6 million jobs last year and there have been a wave of jobs cuts that have been announced in the first quarter as corporation desperately seek ways to cut costs.

In related news, the Fed announced it was keeping interest rates at zero percent for the time being and is likely to start purchasing Treasury Securities on the open market.  Their desire is to keep yields fairly low with the government about to add significantly to the national debt with it’s massive spending increases.

My only worry is that the new stimulus plans doesn’t focus on the housing situation enough and that the current plan will be a mere band aid on the economy like the initial stimulus plan that was passed a year ago.

The hardest hit sectors during the economic downturn have been housing and financial services but now we are seeing waves of job cuts spreading through the rest of the economy.  Most estimates have the economy losing an additional 500,000 jobs this month as the recession in this country intensifies.

We are also see earnings forecasts being cut across the board as many corporations see the recession lasting well into 2009 if not longer.  Companies are tightening their belts and are cutting costs and job losses are expected to climb in the months ahead.

As the economy continues to pull back, consumer confidence is expected to fall even further and rising unemployment figures could send consumer spending spiraling downwards.  The question is how quickly can the new administration put into effect it’s proposed $850 billion stimulus package.

There does appear to be some light at the end of the tunnel however, it was reported today that sales of existing homes rose 6.5% last month.  If the Fed can expand it’s liquidity operations and can return lending activity to some kind of normalcy, there is demand out there for housing but whether there is enough credit to finance that demand is the big question.

Even then, demand for distressed homes doesn’t equate to rising home prices and like many others, I feel that there can’t be any meaningful rebound until the housing market can recover.