Fed's Rescue Plan

by John M. Curtis
(310) 204-8700

Copyright January 28, 2009
All Rights Reserved.                    

          Acknowledging the deteriorating economy, the Federal Reserve Board’s Open Market Committee announced it would keep the Federal Funds Rate between 0-0.25%.  Keeping overnight loans to commercial banks at virtually zero, the Fed admits to the worst economy since the Great Depression.  Holding rates at virtually zero means the Fed doesn’t see economic recovery anytime soon.  Fed Chairman Ben Bernanke said he would keep rates at the current level for “some time,” signaling more trouble ahead for the economy.  Losing 2.6 million jobs last year with prospects for 2009 no better doesn’t bode well for the near future.  Despite the bad news, the Dow Jones Industrial Average rallied nearly 200 points, in part related to bargain hunting in financial stocks.  Wells Fargo & Co. rose over 30%, signaling speculation in the financials, hammered down in recent weeks.

            President Barack Obama pushed hard on Capitol Hill for a bipartisan consensus on his $825 billion economic stimulus plan.  He ran into some GOP opposition, uncertain how his plan differs from former President George W. Bush, whose first $350 billion did little to resuscitate ailing credit markets.  Obama and his recently approved Treasury Secretary Timothy Geithner enjoys the luxury of spending the second $350 billion, trying finally to make a dent in the growing foreclosure problem.  Without dealing with the housing market, the Fed knows it can’t expect much improvement in Gross Domestic Product anytime soon.  Consumer spending, driven largely by healthy employment and homeownership, can’t improve unless there’s a fix for the foreclosure crisis.  Like consumers, corporations begin spending again once investors start  buying commonly traded stocks.

            Reading the tealeaves, the Fed sees lowered manufacturing with all related businesses, including suppliers and transportation.  Creating demand in consumers by (a) releasing more credit, (b) reducing foreclosures, (c) refinancing bad mortgages and (d) opening more home equity lines should help fuel consumer spending.  Barack’s stimulus plan aims to reduce unemployment by subsidizing government infrastructure and creating more alternative energy technology.  While it’s a good start, more stimulus needs to address the flagging private sector where most jobs are created.  Government largess can only go so far in mitigating recession.   Senate Minority Leader John Boehner (R-Ohio) reminds the new president that attention must be paid to the private sector, including more individual and business tax cuts.  Boehner doesn’t want the stimulus weighted on government largess.

               There’s little consensus on the best way to go with a new stimulus plan.  All agree that more stimulus is needed.  Where there’s disagreement is on how much should be spent in different areas.  “The economy has weakened further,” said Richmond Fed Bank President Jeffrey Lacker, echoing the FOMC’s decision to keep rates at the current level.  More consensus is needed on what to do with toxic assets still bedeviling the banks. Treasury Secretary Geithner wants the Federal Deposit Insurance Corporation to open a so-called “bad bank” to buy the toxic debt still swamping the banks, freezing credit markets.  By taking bad assets off the books, the FDIC would help further the rally in financial stocks, just now showing some life.  Bank of America, the nation’s largest bank, that recently acquired Countrywide and Merrill Lynch, watched its stock rise over 30% in the last three trading sessions.

            Money from the first leg of Bush’s bailout is just beginning to trickle down to banks.  While credit markets have been frozen for months, there’s new evidence of lending activity.  “Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions, nevertheless, credit conditions for households and firms remain extremely tight,” said the Fed.  They announced a new $200 billion program aimed at loosening credit for student loans, cars, credit cards and small businesses.  Fed officials say they will begin buying securities used to back various types of loans.  Beranke pledged to “employ all available tools” to stop an deflationary cycle pushing down consumer prices but also wages and standard of living.  Fed officials predict “a gradual recovery in economic activity will being later this year," warning “that the downside risks are high.”

            Beranke sees weakness in all economic sectors, prompting the FOMC to keep interest rates at historic lows.  “Industrial production, housing starts and employment have continue to decline steadily as consumers and businesses have cut back spending,” said Bernanke. “Furthermore, global demands appears to be slowing significantly,” signaling the recession has spread overseas.  Economists  predict the economy will contract in the first quarter about 5.4%, nearing the 6.4% contraction seen in the 1982 recession.  At that time, former Fed Chairman and now Obama economic advisor Paul Volcker hiked rates to kill inflation, plunging the economy into recession.  Today/s crisis calls for more than a partisan plan.  President Obama should urgently convene an economic summit with the nation’s leading experts to fashion the best stimulus plan to fix the economy.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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