Federal Reserve & Interest Rates

Three of the nation’s largest banks, JPMorgan Chase, Citigroup and Bank of America have all agreed to institute a temporary moratorium on foreclosures.  Government officials have been pushing for the moratorium until the financial stability plan from the Treasury Secretary Timothy Geithner can be fully unveiled.

Many banks are also waiting to see how much money will actually be allocated to housing from the soon to be passed stimulus package.  Right now, it is believed between $50 billion and $100 billion will be used to help forestall rising foreclosure but that isn’t nearly enough to turn around the worst housing slump since the Great Depression.

The Fed is still in the initial phases of it’s plan to purchase mortgage securities from GSEs, Fannie Mae and Freddie Mac.  Mortgage rates have come down slightly but the banking system still on shaky ground, there just isn’t enough available credit to meet the amount of demand for housing with prices having fallen so low.

It is hoped that the financial stability plan will contain substantial provisions for the housing market but at this time it is still unclear.  Until the housing markets improves, banks will be weighed down by toxic mortgage assets and until the credit situation improves, the potential demand for housing will be just that.

 So far, there has been a lack of coordination by the government in dealing with the housing and credit situation.  Compared to the amount of money the government has already shelled out to unfreeze credit markets, what has been done to help the housing market has been very little.

Together with balance sheet operations from the Federal Reserve, the actions by Congress and the Treasury the government hopes it can fuel demand for housing which can in turn help alleviate some of the pressure on the banking system.  Otherwise the only other option may be to spend trillions in trying to clear toxic assets off the banking system’s balance sheets. 

On Tuesday, Treasury Secretary Timothy Geithner unveiled his new financial stability plan that will hopefully jump start a banking system clogged down by toxic assets.  The current financial crisis brought on by the housing collapse has fueled the world’s worst recession since the Great Depression.

Governments and central banks around the world pursued policies that, with the benefit of hindsight, caused a huge global boom in credit, pushing up housing prices and financial markets to levels that defied gravity.

Investors and banks took risks they did not understand. Individuals, businesses, and governments borrowed beyond their means. The rewards that went to financial executives departed from any realistic appreciation of risk.

The main focus of the plan is to remove toxic assets from bank balance sheets so that credit can flow normally again.  The question from the beginning has always been how to put a price on these hard to value assets.

By insuring investors from losses, the government wants to re-open secondary securitization markets in order to finance credit creation.  Unfortunately the reason these assets are toxic in the first place is because of the collapse of the housing market.

The plan does little to address the fact without a comprehensive plan to address the housing situation, taxpayers are likely going to take it in the teeth with the government insuring these toxic assets.  These mortgage assets were created during a credit explosion that fueled a gigantic housing bubble, so unless that those two scenarios magically happen again, these assets will never regain their initial value.

Since the private market place is currently unwilling to finance credit creation, that leaves the government with the only option of opening it’s wallet in order to prop up a banking system that for all practical purposes can be considered insolvent.  Normally when a bank goes under, the equity holders are wiped out and the remaining assets are sold.

As we have already seen, the government has already intervened with stupendous bailouts of Bank of America and Citigroup, two of the nation’s largest banking institutions.  The government is pretty much keeping the banking system on life support until private investment returns but anyone who thinks that will be cheap, is sadly mistaken.

The Labor Department released it’s January jobs report and the unemployment situation is growing steadily worse every month.  Unemployment has accelerated in the past few months and the slew of job cuts announced by a number of companies in January looks to see that trend continue for the foreseeable future.

 Nonfarm payroll employment fell sharply in January (-598,000) and the unemployment rate rose from 7.2 to 7.6 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  Payroll employment has declined by 3.6 million since the start of the recession in December 2007; about one-half of this decline occurred in the past 3 months.  In January, job losses were large and widespread across nearly all major industry sectors.

It is hoped that Congress can agree on $825 billion stimulus package some time in the next week.  The House has already approved it’s version and is waiting on the Senate before they can reconcile the differences in the two plans.

At this point is expected that the stimulus plan will contain about $250 billion in tax cuts and around $550 billion in fiscal spending.  While the stimulus plan is expected to create between 1 million and 3 million jobs, that will be over the next two to three years. 

In the short run, the stimulus plan will do little to impact unemployment in the next few months but hopefully it can instill a little confidence in markets that have been hit hard during the past year.  Stocks rose on the feeling that today’s job report will spur Congress in finalizing it’s stimulus plan. 

On Monday, the new Treasury Secretary Timothy Geithner is expected to release a new bank rescue plan that can hopefully stabilize credit markets.  Many people are wondering what kind of plan he will recommend to deal with the approximately $4 trillion in toxic assets that is choking the life out of the banking system.

Despite the stupendous amounts of money that has already been spent, there are some economists who feel that in order to avoid a mini-depression the government will need a stimulus package in the trillions to really make a difference.