Even as Congress leans toward approving a controversial auto industry bailout and Democrats prepare a massive stimulus package, the heads of the Federal Reserve and Treasury are signaling that they, too, are planning more steps to ease credit and jump-start the economy.
With most economists expecting the Fed to cut the federal funds rate again at its mid-December meeting, the big buzz involves what new credit-easing measures may be in the works.
Thus far this week, both Treasury Secretary Henry Paulson and Fed Chairman Chairman Ben Bernanke have either hinted at or made vague references to new measures. And given their use of innovative tools in trying to manage the crisis to date, it’s likely the two policymakers will continue to try as many things as possible.
“They've got to save this thing right now; they can't let the momentum get away from them,” says veteran money manager Jim Awad of Zephyr Management. “And, yes I think they're going to throw everything at it.”
Though some of the previous measures have had little—if any, impact—say economists, it’s the cumulative effect that counts: New measures will underscore that approach and also show leadership during the presidential transition period.
“They want to give people the encouragement that there’s more they can do, that they’re not out of bullets,” says economist Christopher Rupkey of Bank of Mitsubishi-Tokyo.
Bullets, yes. Silver bullets, no—or at least not yet. Here’s a look at what policymakers might do in the near term—as well as the obstacles involved—and the big guns they may have to resort to in the end.
Housing, Housing, Housing
Economists say even though Bernanke and Paulson have taken expensive and aggressive steps to prop up financial institutions, they have yet to result in much lending.
“The banks are like the roach motels—the money goes in and doesn't come out, the rate cuts go in and don't come out,” quips Fact & Opinion Chief Economist Robert Brusca, in a twist on the snappy ad slogan for the innovative pest control product.
Changing that is now the biggest challenge and the current focus. That a point was underscored by recent measures, such as buying mortgage-backed securities, as well as comments by Bernanke and Paulson about forthcoming steps.
In a speech this week, Paulson said they are developing “additional programs to strengthen … so that lending flows into our economy.”
On the same day, Bernanke talked about “helping to spur aggregate demand,” saying the Fed could buy longer-term Treasury or agency securities on the open market in substantial quantities. Economists say the clear goal would be to lower mortgage rates, although there’s significant disagreement about whether it would work.
“The Fed is trying to do what it can do to send a message to banks that it wants rates lower,” says Brusca.
Perhaps by no coincidence, such a move—what some call quantitative easing—was essentially endorsed by St. Louis Federal Reserve President James Bullard Tuesday.
“They can and should and probably will do more to deal with mortgages,” says Robert Glauber, a top Treasury Dept official in the first Bush Administration. “They need to find ways to restructure whole loans, as the FDIC is doing.”
Paulson has repeatedly stressed the important role of the housing market in the financial crisis but has been criticized for doing little, if anything, to aid homeowners.
Glauber and others point out that officials have been thwarted by a system that encouraged the massive securitization of mortgages and other loans, which complicates their restructuring.
“It creates bureaucratic and legal impediments,“ says Glauber. “It makes it hard to change the terms.”
Others suggest policymakers need to do more to support the corporate bond market. Brusca, for one, says there could be more direct government lending, such as financing the commercial paper of auto companies.
“What they're struggling with now is the credit universe of Fortune 500 companies whose credit costs have gone through the roof,” says Rupkey.
"You can judge success when corporates do better than Treasurys," adds Awad. "And when corporate bonds do better, stocks will follow.”
Silver Bullets, Drastic Steps
Some say bolder, more drastic steps are needed.
Solving the lending problem, for instance, might require allowing Fannie Mae and Freddie Mac to lend money, rather than simply guarantee mortgages, or nationalizing the banks, given the amount of aid that's been given to ones like Citigroup (NYSE: C).
Others say the mark-to-market accounting rule must go.
“The failure to force the SEC to get on the same page with the rest of government by suspending its failed and highly destruction market value accounting rules outweighs all of the other failures combined,” says former FDIC Chairman William Isaac. “It is insane to be using taxpayer funds to recapitalize financial companies when the SEC is allowed to continue destroying the capital almost as fast as it is being put in."
The so-called Wall Street bailout legislation creating the TARP restated the SEC’s authority to drop mark to market if it was in the interest of taxpayers as well as investors. The European Union almost did it before a last minute retreat.
Such a move clearly has global implications. It might also need to wait for a new Congress, and president, not to mention, SEC chairman. Together, that may put it in the remedies-of-last resort category.
Short term, the he best measure of success may be what doesn’t happen as opposed to what does happen. Many consider another major corporate failure—on the scale of Lehman Brothers—would be a major blow.
“You have liquidity,” says Awad. “What you don't have is confidence.”
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