Personal Finance Advice

Starting in the 1970’s, the banking system has undergone a long cycle of deregulation.  The culmination of all this was the repeal of the Glass-Steagall Act in 1999 which has since muddied the distinctions between banks, securities firms and the insurance industry when they began a period of consolidation.

The arguments for deregulation was to foster a climate of competition, innovation and lower prices by lessening government oversight and allowing  market forces to dictate the flow of credit.  Since then financial sector has experienced a rapid expansion by offering many new products and services.

After this current financial crisis is over, I think we can expect things turn back the other way.  While the collapse of the housing bubble was the main cause of our current economic troubles, no one can deny that the financial sector has it’s fair share of the blame for all this.  Lax lending standards and excessive risk taking through the explosive growth of securitization and derivatives has created a highly leveraged financial machine that is at it’s breaking point.

Unfortunately because the financial system is so intertwined now, market forces can’t be allowed to reach their ultimate conclusion, the collapse of a large number of financial institutions, no matter how much they deserve to go out of business.  The Federal Reserve has had to step in and use powers it hasn’t needed since the Great Depression in order to keep the banking system from collapsing.

One thing is for certain though, the larger the final cost to taxpayers, the more lawmakers will call for an increase of regulatory oversight of the financial services industry and that might not necessarily be a bad thing.

The report released by the National Association of Realtors was the first bit of good news the housing market has seen in some time.  Home sales rose for the first time in seven months in the month of February.  Home prices are still falling though, which is a cause for concern.  The median sales price is down 8.2% from a year ago.

While this gives a glimpse that the housing market may soon be bottoming out, it doesn’t mean that sub prime crisis is over yet by a long shot.  All this really does at the moment is give the stock market a reason to rally for another day until the next bit of bad news comes along.

The problems with the banking sector are still there.  Only a week removed from the near bankruptcy of Bear Stearns, the financial sector is still gripped in a major credit crisis.

Many homeowners are still stuck with unwieldy mortgages that are worth more than the price of their homes, so the foreclosure risk remains.  So far, write downs from the sub prime collapse are estimated around $200 billion but many experts are predicting that figure could rise to as high as $500 billion before all is said and done.

While it appears that the Fed is willing to use any tool necessary to instill liquidity in the market, the fact remains that banks have tightened their lending standards considerably.  While the Fed has been slashing interest rates left and right, mortgage rates still remain abnormally high.

So while the slump in the housing market has caused the current troubles in the financial markets, it’s looking more and more likely that the financial markets will constrain a possible rebound in the housing market.

Economists were surprise on Friday when the Labor Department released inflation figures for the month of February.  The Consumer Price Index remained unchanged for the month after it was expected to rise by 0.3 percent.

The report could open the door for a full percentage point rate cut when the Fed is scheduled to meet on Tuesday.  Futures traders had been betting on a 75 basis points cut but many were increasing their bets for a full point cut after the report was released.

However, inflation is still a concern, with oil trading above $110 a barrel and gold breaking the $1,000 an ounce mark for the first time ever.  The fact remains though that with core prices remaining virtually unchanged, it does allow the Fed to act more aggressively in it’s policy initiatives in the near future.

The situation in the credit markets may force the Fed to do just that.  On Friday, the Fed along with JPMorgan moved to provide emergency funding for Bear Stearns Co., preventing the imminent collapse of the nation’s second largest underwriter for mortgage backed securities. 

It was a break in tradition for the Fed, which normally doesn’t interact with non-traditional banks in this manner.  However, desperate times call for desperate measures and the collapse of the investment bank would have sent shock waves through the entire financial sector.  With many firms struggling in a ever worsening credit crisis, the Fed may have to act again in the future to prevent the failures of other financial institutions.

There is a fear that this is a bad precedent being set, that firms can invest irresponsibly, only to hold out their hands to the Fed in their times of need.  Nonetheless the Fed had to act in this case because the alternative would have been unthinkable.