Federal Reserve & Interest Rates

Federal Reserve Chairman Ben Bernanke gave an overview on Monday, on the impact of the financial crisis on Asia’s largest economies and it’s policy responses.  The growth in global trade allowed the financial crisis which began it this country to transmit it’s effects to the rest of the world, and Asian economies were hit hard but aggressive policy actions by many of those countries appears to have paid off.

In September and October 2008, as you know, the global financial crisis intensified dramatically.  Concerted international action prevented a global financial meltdown, but the effects of the crisis on asset prices, credit availability, and consumer and business confidence resulted in sharp declines in demand and production worldwide.  Reflecting this worsening economic climate, Asian GDP growth slowed further in the second half of 2008. 

For the region as a whole, the economic contraction in the fourth quarter of 2008 was pronounced, with activity falling at an annual rate of nearly 7 percent.  The fourth-quarter declines were especially dramatic in Taiwan and Thailand (more than 20 percent at an annual rate) and in South Korea and Singapore (more than 15 percent at an annual rate).  Among the major Asian economies, only those of China, India, and Indonesia did not contract during the crisis.

For most Asian countries, the severe drop off in global trade as well as disruptions in international capital flows played a large factor in the recessions of those countries.  However, low inflation levels allowed most of those countries to take aggressive stimulus actions and their economies appear to be on the brink of recovery.

Large trade and capital flow imbalances helped transmit financial instability to their economies and Bernanke points out that efforts need to be taken in the future to prevent this.  The United States need to increase it’s national savings rate but the large federal deficits expected over the next decade may make this difficult, on the flip side, Asian countries could reduce their overall savings rate by promoting domestic consumption, which may also prove difficult.

The lessons learned from the financial crisis has proved that global economies must take cooperative fiscal and monetary policy measures which are mutually beneficial.

Nearly a hundred banks have already failed this year and the FDIC’s bad bank list contains hundreds more that are in danger of failing in the next few years.  With it’s insurance fund running dangerously low, the FDIC put forward a plan earlier this month, in which banks would prepay three years worth of fees to replenish the fund.

It’s the worst stretch of bank failures since the Savings and Loan crisis of the 1990’s when nearly two hundred banks and thrifts failed, costing taxpayers over $100 billion.  The insurance fund has shrunk by nearly $35 billion since the recession began and has a little over $10 billion remaining.

While banking system has stabilized somewhat, it’s still in a fragile state and the continued weakness in the residential and commercial real estate markets will lead to more failures in the next few years.  At this point, the FDIC estimates that bank failures will cost the insurance fund $100 billion by 2013.

The proposed prepayment plan is expected to raise somewhere in the neighborhood $50 billion and while the banking industry isn’t happy about it, they prefer this option to a special fee assessment which was also a possibility. In May, Congress increased the FDIC’s line of credit with the Treasury to $100 billion, but it been reluctant thus far to borrow from the Treasury and putting more of the onus of bank failures on taxpayers.

Federal Reserve Vice Chairman Donald Kohn gave his views on the current economic outlook in a speech on Tuesday.

In broad terms, the data that we have in hand indicate that economic activity turned up in the third quarter. To some extent, the pickup in activity in recent months reflects the dissipation of some of the forces that had been exerting downward pressure on the economy during the preceding several quarters.

Perhaps the most important of these downward forces was the turmoil in financial markets that began in late 2007, which not only tightened credit availability and reduced wealth, but also undermined confidence, especially when conditions took a decided turn for the worse in the fall of 2008.

The stabilization, and more recently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.

Although the financial system has stabilized somewhat, credit has remained tighter than they would wish.  The Fed still has extensive excess bank reserves on deposit but as economic conditions improve, it is hoped that institutions will lend more freely.

The labor market is still a hurdle that the economy has to get through and while job losses are slowing, the downward trend is expected to continue for a few more months and it could take years for it to fully recover.  Many economists feel that the unemployment rate could remain above 9% mark into 2011.

The housing market also remains a problem for the economy but hopefully as credit conditions improve, that will translate into increased sales activity.  Consumer spending will also likely remain somewhat muted until labor conditions start improving once again but demand has picked up in the past few months.

A lot of people are starting to see the light at the end of the tunnel and hopefully in the months ahead, this view will be re-enforced.