财经观察 1307 --- A successful bailout? Watch lending between banks

A successful bailout? Watch lending between banks

Sunday September 28, 4:14 pm ET
By Jeannine Aversa, AP Economics Writer

Bailout's success will be evident once banks begin lending freely to each other -- and then us

WASHINGTON (AP) -- The New Deal it is not.

The government's biggest economic bailout since the Great Depression is aimed not at relieving unemployment or reforming questionable business practices, but at resuscitating financial markets debilitated by lousy bets on the housing market.

Put simply, the hastily crafted plan lawmakers agreed to in principle on Sunday is intended to revive jittery and fragile banks on Wall Street and Main Street with enough money -- by using taxpayer funds to purchase billions upon billions of their worst mortgage-related assets -- so that lending, the lifeblood of the American economy, flows freely again.

If it is working, signs will emerge almost immediately in the interest rates on short-term Treasury securities and in an array of obscure -- but crucial -- financial benchmarks.

Loans -- particularly those made from one bank to another -- would be more available and less expensive in a matter of weeks, if not days.

And as the government gobbles the banks' toxic assets, the industry would gain the confidence and strength needed to make it easier and cheaper for families to borrow for homes, cars and college -- and for businesses to secure ample debt to pay for plants, equipment and workers.

Still, rising unemployment, high energy prices and falling real estate values will not disappear overnight -- and there's no guarantee a recession will be avoided.

"At first, there will be some sort of sigh of relief, which I'm afraid would be misplaced, because when you get through the shorter-term terror, you're left with an economic landscape that will be very fragile," said Michael Farr, president of Farr, Miller & Washington, which manages investment portfolios for people and businesses.

Were the clogged credit markets of the past year -- and more crucially, the past few weeks -- left to fester without a massive government intervention, the United States faced a financial calamity that could have plunged the economy into a deep recession, putting the livelihoods and investments of millions of ordinary Americans at risk, President Bush and Federal Reserve Chairman Ben Bernanke warned.

"Bernanke told us that our American economy's arteries, our financial system, is clogged, and if we don't act, the patient will surely suffer a heart attack maybe next week, maybe in six months, but it will happen," said Sen. Chuck Schumer, D-N.Y., chairman of Congress' Joint Economic Committee.

Once the liquidity floodgates have been opened -- the government will have as much as $700 billion at its disposal to buy banks' bad mortgages and other rotten assets -- the benefits of the bailout proposed by Treasury Secretary Henry Paulson and modified by Congress are expected to trickle down through the rest of the economy. But Americans should be braced to feel economic pain well into next year.

More people will lose their jobs, foreclosures will go up, paychecks will be strained and home values -- people's single biggest asset -- will keep falling, experts predict.

Even if the plan is successful, many predict the economy will probably shrink in the final quarter of this year and in the first quarter of next year, meeting the classic definition of a recession. The unemployment rate -- now at a five-year high of 6.1 percent -- is expected to hit 7 or 7.5 percent by late 2009. That would be the highest jobless rate since after the 1990-91 recession.

So, how exactly will we know if the credit clog is breaking up?

Some of the banking industry's first responses won't be immediately visible to most Americans, but they are critical to the proper functioning of the U.S. financial system.

For instance, a drop in a crucial short-term lending rate called the London Interbank Offered Rate, or Libor, would be a telltale sign that banks are less anxious about extending credit to each other -- and the rest of us.

Libor is the rate many banks pay for the short-term loans essential to their daily operations. It's also the base rate for an enormous amount of commercial lending and for many adjustable-rate mortgages. On Friday, the six-month Libor rate was 2.3 percentage points above comparable Treasury bills. Last year, the difference was 1.2 percentage points.

Another sign of growing confidence in financial markets would be lower rates on "commercial paper," a crucial short-term borrowing mechanism that many companies rely on for financing day-to-day operations, including payrolls and other expenses.

Economists said a properly designed bailout should also cause interest rates on short-term Treasury securities to rise relatively quickly.

As the financial crisis worsened, investors fled risky types of debt and flocked to these ultra-safe securities backed by the full faith and credit of the U.S. government, driving down their yields. In a sign of just how spooked investors have become, the 3-month Treasury bill's yield has fallen below 1 percent, compared with a yield of nearly 4 percent a year ago.

"The recovery process is going to come in stages, not in one fell swoop," said Terry Connelly, dean of Golden Gate University's Ageno School of Business. "The credit markets had a stroke. We are in intensive care now. We will have to learn how to walk and talk again."

As credit markets thaw, rates should also begin to fall on a type of corporate-debt insurance known as credit default swaps.

While not a household word, these derivatives figured prominently in the country's financial crisis. Prices for credit default swaps soared in the aftermath of the Lehman Brothers' bankruptcy and pushed American International Group Inc., a major insurer of this kind of corporate debt, into the hands of the government following an $85 billion emergency loan funded by taxpayers.

Assuming these more obscure corners of the financial markets are on solid footing again, consumers should eventually begin to have an easier time taking out loans for homes, cars, furniture and college.

Over time, a healthier financial system should help the value of the dollar rise versus other currencies, reflecting renewed confidence in the U.S. economy and blunting inflationary pressures that have made Americans feel less wealthy.

But it is only after a wide range of industries feel confident that the economic and financial conditions have fully recovered that they will start to ramp up hiring, perhaps by 2010. House prices should stop falling in the summer of 2009 and may start rising in 2010, economists said.

In the short term, there are several economic reports to watch for clues about whether credit conditions are improving:

-- The Federal Reserve's weekly report on emergency loans provided to banks and investment firms is a barometer for how strapped they are for cash;

-- Freddie Mac's weekly report on mortgage rates shows what home buyers are being charged to borrow;

-- The Mortgage Bankers Association's quarterly survey of home foreclosures and delinquencies will indicate whether the struggling housing market is on the mend.

-- The Fed's quarterly senior loan officers' survey tracks banks' appetite to lend.

The heart of the bailout plan gives the government authority to relieve financial institutions of the distressed mortgages and other bad assets on their books. Getting dodgy assets off the books of hobbled banks will make it easier for them to attract fresh capital and boost lending.

As Lehman, AIG and other major financial companies racked up huge losses and saw more coming, credit problems spread globally, firms hoarded cash and they all clamped down on lending. That crimped consumer and business spending, and dragged down the economy -- a vicious cycle Washington lawmakers hope to break with this historic bailout.

"It's just a huge negative psychology that will be hard to turn around," said William Dunkelberg, chief economist for the National Federation of Independent Business and an economics professor at Temple University.

Adds Sean Snaith, economics professor at the University of Central Florida: "If someone slights you today, it is going to be hard to immediately trust them the next day. It will take time for that confidence to be restored."

Who wins, who loses under proposed bailout plan?
Sunday September 28, 4:17 pm ET
By Tom Raum, Associated Press Writer

Financial industry a big winner in bailout proposal, but not so troubled homeowners

WASHINGTON (AP) -- The proposal to bail out U.S. financial markets to the tune of up to $700 billion creates a lot of potential short-term winners, as well as some losers.

Wall Street and the banking industry are perhaps the biggest winners. Scores of banks and other financial institutions faced with going under stand to gain a lifeline that should allow them to start making loans again.

Under the plan that congressional aide sought to put into final form Sunday, the Treasury Department can start buying up troubled mortgage-related securities now held by these institutions.

These securities are clogging balance sheets, leaving banks without the required capital to make new loans and putting the banks dangerously close to insolvency.

Banks not only have slowed lending to individuals and businesses, they have stopped making loans to each other. The rescue plan should help restore confidence to financial markets.

There are other winners, too, if the bailout works as intended: anyone soon trying to borrow money -- for cars, student loans, even to open new credit card accounts.

Top executives at troubled financial institutions, on the other hand, are in the losing column because the proposal would limit their compensation and rules out "golden parachutes."

Of course, these executives may take solace in knowing their jobs still exist.

Investors, including the millions of people who hold stock in their 401(k) and pension plans, should benefit. Failure to reach a deal over the weekend could have sent stock markets around the world tumbling on Monday.

Homeowners faced with foreclosure or those who have lost their homes get little help from the agreement. Nor will it help people whose houses are worth less than what they owe get refinancing or take out equity loans.

It would do little to halt the slide in home values that are one of the root causes of the current economic slowdown.

"It doesn't deal with the fundamental problems that gave rise to the problem -- or alleviate the credit crisis," said Peter Morici, an economist and business professor at the University of Maryland

Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke are potential winners.

In just a few months, they have remade Wall Street. If the plan helps to get the economy moving again, they may be remembered for having kept the financial crisis from spreading throughout the economy.

"When I see Hank Paulson and Ben Bernanke on TV, I see fear in their eyes. Like on a battlefield when people are shooting at you. I think they are afraid to say how serious the problem is for fear of making it worse," said Bruce Bartlett, an economist who was a Treasury official under the first President Bush.

Bartlett said the plan is flawed, yet the alternative of doing nothing could be catastrophic.

After the heavy dose of new regulation in the agreement, New York will have a hard time claiming it is the center of the financial universe. That title may have shifted to Washington.

If the plan stays together, Congress -- with approval ratings even lower than those of President Bush -- may be seen as having acted decisively at a time of national emergency.

Congressional leaders added new protections to the administration's original proposal. That was only three pages long and bestowed on the treasury secretary almost unfettered powers.

Instead, the agreement would divide the $700 billion up into as many as three installments, creates an oversight board to monitor the treasury secretary's actions and set up several major protections for taxpayers, including a provision putting taxpayers first in line to recover assets if a participating company fails.

The president, on the other hand, probably would get little credit for the deal. He allowed Paulson and Bernanke to do the heavy lifting. The only time he called all the players to the White House -- late Thursday afternoon -- the wheels almost came off the process entirely.

It's hard to tell which presidential candidate benefits the most from an agreement they tentatively endorsed Sunday, a little more than five weeks before the Nov. 4 election. Democrat Barack Obama and Republican John McCain each sought to claim some credit for the deal, even though they played active roles only over the past few days.

Hard economic times traditionally work against the party that holds the White House, and in recent polls Obama has inched ahead of McCain. Furthermore, there is widespread consumer resentment over being asked to bail out Wall Street and lawmakers have learned the proposal has not been popular with their constituents.

That may help Democrats in general. The strongest opposition to the original bailout plan came from House Republicans.

Lawmakers and presidential candidates alike are "trying to orchestrate everybody jumping off the cliff together," said Robert Shapiro, a consultant who was an economic adviser to President Clinton. "I think we'd have a different plan if we weren't five weeks out from the election."

And ordinary taxpayers?

Nothing that potentially adds $700 billion to the national debt -- already surging toward the $10 trillion mark -- can be considered a winner for those who foot the bills.

But lawmakers did put in taxpayer protections, including one to require that taxpayers be repaid in full for loans that go bad.

The package could even end up making money for taxpayers, supporters claimed.

But only if the loans and interest on them are repaid in full. Few expect that provision to be a winning proposition, however.