To get the “Patient “ i.e. the economy out of intensive care the government in the US has now embarked upon addressing the three BIG issues which it believes are at the forefront of fixing the economy.
So what are these three BIG issues? The downturn in the economy, a very sick financial sector and a paralyzed housing market
Let’s see how the government officials are trying to address or shall I say tackle these issues.
FIXING THE FINANCIAL SECTOR
So what’s the proposal for fixing a very sick financial services sector i.e. the banks?
Under the proposed financial stability plan the first on the list of items deals with a compulsory “stress testing” for banks with over US 100 billion in assets. With this testing the treasury hopes to determine the exact exposure of individual banks to toxic assets. Through the capital assistance program the treasury will provide capital injections where needed with clear lending requirements and limits on dividends, stock repurchase, acquisition and compensation etc. These investments made by the treasury will be kept under a trust called “ Financial Stability Trust” although the treasury has not shed more light on the options available to severely undercapitalized financial institutions on prima-facie this is a step in the right direction.
The second on the list is what market is calling a Public-Private Investment Fund (PPIF).Well, we all know the price tag for a probable fix is going to be around US 2 trillion (for now at least). A big part of it is supposed to come from the government and the rest from private investors. The idea is to use this vehicle (whatever you want to call it) to absorb the toxic assets sitting in the balance sheets of the banks at a cost and hope to make some money when the valuation recovers. Under the draft proposed plan it is believed that the government through treasury will provide some sort of guarantee and loans from Federal Reserve will limit the downside risk to private sector investors. These loans will be on top of the Fed’s existing commitment in the amount of over US 2.4 trillion to support a dysfunctional financial system. It is assumed that the government will rely heavily on the skills of the private investors to correctly price these toxic assets (and in some cases DEAD assets). It is safe to say that some of these assets will recover from their current valuation over a period time but what we can’t safely say is how much. The fear is that a good chunk of these toxic assets are shall we say DEAD assets with no hope of recovery. So it’s unclear to see how the proposed partnership will make money from this exercise. Similar initiatives taken by the Japanese government over a decade ago (in the 90’s) didn’t deliver the desired result and eventually they had to make the tough call of nationalizing banks with insufficient capital. An average of all projections suggests that the total loss on U.S. securities and loans could reach over US3.3 trillion dollars of this over US 1.6 trillion will have to absorbed the by US based banks. The consensus view is that the banks will require additional capital to keep afloat as the losses mounts. We will have to wait and see. Surely, there is a need to learn the lessons from the past and if past is a guide to the future then it looks like we haven’t learnt MUCH!
The third on the list is a Fed’s initiative called Term Asset Backed Loan Facility a.k.a TALF which is aimed at auto, consumer and student loans. We will have to wait and see how these initiatives play out in the end.
PLAN FOR FIXING THE ECONOMY
The BIG question on everybody’s mind is will the mother of all stimulus packages deliver the BIG BANG the US economy desperately needs?
The recently approved US 787 billion fiscal stimulus package has had a mixed reaction from the market. The question is how will the stimulus package benefit the US economy and the tax payers are probably asking themselves WHAT WILL THIS STIMULUS PACKAGE GET US besides putting an enormous stress on the fiscal deficit of the country. These outflows along with other spending will drive the U.S. fiscal deficit over $ 1.7 trillion (based on estimates) and the government debt/GDP ratio over 85% in the financial year 09. Taking this entire spending spree into account one has to believe that the Government surely thinks that the stimulus package will deliver the goods.
So what’s the aim of the package?
At the forefront of it is creating or saving jobs. The hope is to arrest the mounting job losses by creating over 3 million jobs and get the consumers spending again by providing them with cash tax credit.
Huge chunk of the money will be spent on infrastructure (roads and bridges), school projects, energy efficient buildings, renewable energy and new power lines that would distribute energy from renewable sources, various other projects including of water and public transit and emergency aid to states.
ADDRESSING THE PARALYZED HOUSING MARKET
Some in the US (especially the democrats) have been calling for a housing stimulus bill that will help the struggling home owners stay in their homes and also stop the house prices from falling further. President Obama recently announced an expected plan to fight a deepening housing crisis by committing up to US 275 billion to stop the wave of foreclosures sweeping the US. The plan aims to help around 9 million American families. Under the proposed plan a US 75 billion fund will be formed to reduce the monthly payments for homeowners and provide them a buffer of up to $ 6,000 against any decline in the value of the houses. The treasury will also agree to double its financial aid to Fannie Mae and Freddie Mac enabling them to play a bigger role in supporting the housing sector. The aim is obviously to increase the confidence in Fannie and Freddie ensuring the strength and security of the mortgage market and to help maintain mortgage affordability.
Now the question is what’s the prognosis and will this work?
Well, the short answer will obviously be, it’s too early to tell. We will have to wait and see. Although the package might not be perfect and we could endlessly argue about the pros and cons of the plan, it is probably safe to conclude that these spending should at least arrest the current downward momentum of the economy eventually helping the US economy by putting it on the path to recovery. Surely the focus should be on getting the SICK PATIENT i.e. the economy out of intensive care before making any prognosis of a full recovery, and recover it will.
