Personal Finance Advice

Monday saw the stock market hit a two year low, but what a difference a day makes.  Stocks surged 3 percent for their largest gain in nearly five years after the Fed announced plans for a new $200 billion securities lending program that directly infuses liquidity to twenty of the nation’s largest lenders and investment banks.

Wall Street loves this move because the Fed is offering to accept as collateral, mortgage backed securities, in exchange for Treasury securities which banks will then be able to resell on secondary markets for cash.  Basically the Fed is almost acting as a buyer of last resort, providing a market where none exists.

Whether this plan is large enough in scope remains to be seen but it is a step in the right direction.  Another positive note is that the Fed was able to coordinate this move with other central banks in Canada and Europe, who also plan to inject their banking systems with liquidity, albeit at a much smaller scale, approximately $45 billion.

This move also takes some pressure off of the Fed, whom many have been calling for an emergency rate cut ahead of their regularly scheduled meeting next week.  The futures market is predicting a 75 basis point cut after that meeting.

While this is a nice short term fix, that’s all it really is.  The Fed would prefer that banks lend each other money but right now they don’t trust one another.  The problem is no one wants to buy securitized debt. 

The whole point of securitized debt is to provide short term liquidity for an asset that is illiquid in nature, like a long term loan.  Credit markets are in shambles because banks are stuck with all this debt that they either can’t sell or if they can, at seriously discounted prices.

With the government stepping into the morass of the ongoing mortgage crisis, there are some who don’t think it’s such a great idea.  John Markman of MSN is one who doesn’t think it is.

“The Bush administration intends to fix the subprime credit mess by keeping people who weren’t creditworthy in debt longer and rendering signed contracts meaningless.”

“When banks make a lot of money, after all, they suck down the profits by giving their executives and boards outrageous pay packages worth tens of millions of dollars, justifying their actions under the rubric of entrepreneurship. And when the opposite happens? They beg taxpayers for a handout.”

“The breaking of these obligations will not be free. Foreign investors will demand a higher “risk premium” to invest in U.S. real estate, which will make it more expensive for future mortgage seekers to get loans. And they are bound to sue to get the payments they thought they were owed, which will drive up mortgage banks’ expenses.”

Yes, this plan is rewarding the irresponsible and while on the surface it doesn’t look like any government funds are involved, eventually it will be taxpayers who end up footing the bill.  As was the case in the Savings & Loans fiasco of the 1980’s, once financial institutions begin to fail, they’ll be at Uncle Sam’s doorstep waiting for a handout.

There are no free lunches.  Investors of these mortgage backed securities don’t want to be the ones paying the bill and will sue for their promised returns.  Although, one could argue that those investments are pretty much worthless at this point anyway.

Did the government have any other choice but to step in though?  There are some economists who are predicting that with breakdown of the credit system, we could have the makings of the worst recession since the Great Depression.

Has America leveraged itself into a corner?  For years experts have been predicting that the debt our society kept accumulating wasn’t self sustaining and that dire consequences would be the end result.  Perhaps we have finally reached that point.

With the a new wave of foreclosures about to hit an already beleaguered financial system, the Bush Administration and the mortgage industry decided to finally act. CNN reports that the plan would call for a five year moratorium on introductory “teaser” rates.

How will this affect the stock market?

This should be welcome news for investors. Financial stocks helped drive the market down last month in what many suspected was a prelude to an economic recession. While investors should still be wary, it appears that the worst may be over for now.

How will this affect the financial sector?

Credit markets will still be tight for awhile but this plan along with another expected cut in interest rates will give financial institutions a little wiggle room. They will be hard pressed to recover their previous levels of liquidity with the lack of demand for securitized debt. This will give them the time they need to regain the confidence of investors, who aren’t too happy right now seeing as their returns are being cut due to the rate freeze.

How will this affect homeowners?

It will help some but not the ones who need help the most. The plan does nothing for those that are already in default or are behind on payments. For those it will help it will give them time to hopefully refinance into a fixed mortgage once the credit markets aren’t as tight.

How will this affect the economy?

There is no question that many people thought the economy was teetering on the brink of a recession. Another shock to the financial system might have been the final straw. While it’s possible that this plan is only delaying the inevitable, it does gives time for the fundamental problem to perhaps correct itself.

How will this affect the housing market?

Here we come to the crux of the matter. It was the slump in the housing market the began this whole mess. Well, that and poor lending standards. This plan will help forestall another wave of foreclosed homes on a market that was already over supplied to begin with.

This is where the time length of the freeze becomes important because many analysts expect the housing market to remain soft for the next couple of years. Hopefully by the time the moratorium is set to expire, the housing market will have recovered to the point where it no longer serves as a drag on the banking system and the rest of the economy.