From the April 6, 2008 Sunday Times (London)
April 7, 2008
by Irwin Stelzer
The financial world changed last week, and no one noticed. No one, that is, except policymakers in the Bush administration and the Congress, and the freewheeling investment bankers whose favourite pastime once was trumpeting red-in-tooth-and-claw capitalism. On Thursday staff from the Federal Reserve Board descended on Gold-man Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers to check their liquidity and solvency - who they are lending to, who they are trading with, how much capital they have or can get quickly. It seems that all the leading investment banks, with the possible but not certain exception of Merrill (it won’t say), have availed themselves of the Fed’s new open-handedness.
Until now, and thanks to deregulation passed by Congress in 1999 at the urging of John McCain’s top economic adviser, Phil Gramm, a Texas senator at the time, no such supervision was deemed necessary. That was then, and this is now. Bear Stearns is, or soon will be, no more, taken over by JP Morgan, but only after the Fed, backed by taxpayers’ money, accepted the risk of $29 billion in loans on Bears’s books in exchange for cold, hard cash. More important, Federal Reserve Board chairman Ben Bernanke has agreed to be the cashier of last resort for other investment banks, and says: “We want to be sure that any lending we do to the investment banks will be done on an appropriately sound basis.” That’s a revival of a role the Fed abandoned in the 1990s.
More changes are in store. Americans drowning in a sea of debt are about to receive a lifesaver. Its exact contours are unclear, in part because Congress is not certain how to balance the need to relieve homeowners’ suffering against the danger of rewarding imprudent lending and borrowing. Remember, this is the Congress that passed the Community Reinvestment Act that required the Fed to force banks to increase lending to poor ghetto-dwellers (“underserved communities”) who wanted to buy homes. Enter the sub-prime mortgage problem. The very one that these congressmen now blame on Alan Greenspan’s interest-rate policy, or Bernanke’s failure to audit the banks properly, or investment bankers greedy for megabonuses, or fraud-prone mortgage brokers, or all of the above.
Now we are to have Christmas in April, or at the latest in May. Democrats and Republicans have returned to Washington after a two-week recess in which they were exposed to the complaints of constituents, and agreed that something must be done for overstretched homeowners. That usually results in legislation that resembles a Christmas tree - something for everyone.
Democrats are demanding $100m to provide counselling to at-risk homeowners, and $4 billion in grants to communities to buy and refurbish repossessed properties. Republicans’ gift list includes home-builders, who will get $6 billion in tax breaks. In an attempt to put a stop to declining house prices, Congress is authorising states to issue $10 billion of bonds backed by mortgage revenues to fund the refinancing of existing homes and purchases by first-time homebuyers, and various government agencies to increase their backing for a variety of mortgages. Throw in a $15,000 tax credit for anyone buying a residence facing foreclosure, and you have a Merry April for lots of people.
But you have no real solution to the problems the economy faces. The cure is not going to be concocted in Washington, even if the White House finally withdraws its objections to some of the above-men-tioned congressional measures. It will come in part from the nationalisation of debt implicit in the Bear Stearns bailout. Since investment banks will no longer be allowed to fail, they are finding it possible to raise capital, as Lehman did, and - this lifted spirits - as Merrill says it has no need to do.
Contributing to the restoration of confidence will be the deleveraging of the investment-banking industry as the Fed’s auditors prohibit the inverted pyramid on which Bear Stearns was built - $34 of debt piled onto every $1 of capital. It will come in greater part from the feeling that is taking hold that the huge UBS write-down, followed by the rise in its share price, will finally encourage other banks to come clean, and get their balance sheets more in line with reality. Confidence will be restored when everyone feels the last Gucci loafer has dropped.
So much for the financial sector. The so-called real economy is in or so close to recession that Bernanke finally used the R word. The economy has lost 232,000 nonfarm jobs since the beginning of the year, and the unemployment rate has risen from 4.9% to 5.1%. Americans, spooked by $3-$4 per gallon petrol, are avoiding 4x4s and small trucks, driving down sales of passenger vehicles to the lowest level in a decade. The manufacturing sector is slowing; consumers are more cautious; oil and food prices are painfully high. All true.
But consider Bernanke’s entire comment: “A recession is possible. We’re slightly growing at the moment, but . . . there’s a chance that for the first half as a whole there might be a slight contraction.” Hardly a forecast of the end of the economic world. The manufacturing sector is shrinking, but only slightly.
“We’re moving sideways rather then into a big manufacturing down-turn,” says Norbert Ore, of the Institute of Supply Management. And consumers, who account for 70% of the economy, might not be increasing their spending, but neither are they cutting back. That might come, but so might a boost from the stimulus checks that will be in the mail in about 60 days, and the delayed effect of the Fed’s interest-rate cuts. Be afraid, but not very.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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