Federal Reserve & Interest Rates

Yesterday’s stunning defeat in the House for the $700 billion bank rescue package for the financial system sent shock waves through the stock market and party leaders are already stating that some members are regretting their decisions.  There is renewed optimism that if the bill is brought forth again later this week it will likely pass.

There has been an outpouring of support that has surfaced for the bailout after markets reacted negatively to yesterday’s vote.  What you could say was surprising about the vote is that there were substantial portions of both parties that voted against the measure, about 40 percent of Democrats and two-thirds of Republicans.

The chaos ensuing in financial markets knows no party lines and it is understandable that many members of Congress have reservations of about adding a bailout package to the deficit that is significantly larger than the 2008 Defense Budget.  A major reservation is that once they open the wallet, it may not be the last time.

Analysts have been predicting that the worst has been over for months but that has simply not been the case.  While markets have shown slight rebounds here and there, the fact of the matter is that with so much volatility currently, the slightest bad news can send markets reeling.

Much of the planned bailout package is to be used to prop up a sagging banking system as the government becomes the buyer of last resort for illiquid  mortgage assets in order to free up capital so that banks can start lending again.  The biggest questions are how much the government will pay for these assets and whether this will only serve to transfer losses from financial institutions to the American taxpayers.

A major problem with the rescue plan is that is does little to address the cause of our current financial woes, which is a sagging housing market.  What’s to keep the financial system from needing more money six months down the road because home prices keep falling.

The financial system is at a fragile point and any delay by Congress in approving the bailout of the banking system could have dire consequences.  Lending institutions have been crippled by the credit crisis and their inability to sell illiquid mortgage assets that no one wants to buy.

The industry needs to consolidate but it is a tough time for mergers and acquisitions as the availability of capital is practically nonexistent.  There is a lack of confidence in the banking system and capital markets in general.

It’s going to become increasingly difficult for troubled banks to raise funds because investors don’t want to be left holding the bag when they fail.  They can’t sell stock and they can’t sell bonds and deposits can quickly dry up at the first sign of trouble.

A run of on bank deposits quickly doomed Washington Mutual and it was seized by federal regulators in the biggest failure of a banking institution in U.S. history.  Bank runs could be a common sight in the near future as the continuing troubles of the housing market lead to more losses by financial institutions.

The rate of mortgage defaults and foreclosures continues to grow as home prices keep falling.  Neither the Federal Reserve’s or the government’s actions have seemed to help other than possibly delaying the inevitable.

People are worried about their money and FDIC doesn’t have the capital reserves to pay for all the insured deposits of the growing number of troubled banks.  We could witness a staggering amount of bank failures in the upcoming year if the situation doesn’t start to improve soon.

Will the bailout be enough to fix the problems or is it too little to late?  Whatever happens middle class America is likely going to take it on the chin before this mess is all said and done.

It has become clear that in order to avoid a severe financial catastrophe, the U.S. government is going to have to spend an unprecedented amount of tax payer dollars.

The U.S. Treasury Department is working through the weekend with Congress to craft a plan to spend as much as $700 billion to absorb bad mortgages and other assets from bank or other institution balance sheets to keep the financial system from collapsing.

The Treasury plan, which follows a new federal guarantee for money market fund holdings, would push Washington’s potential bailout tab to $1.8 trillion.

When added to the $300 billion housing bill that entailed the Fannie and Freddie rescue plan, the economic stimulus package, the previous bailout of Bear Stearns, the Fed’s loan to AIG and so forth, you get the picture.  Considering that the existing national debt of the U.S. government is roughly $9 trillion, that’s an additional 20% that could potentially be added to it and with the fact that the financial crisis is far from over, that number could rise even further.

The long term repercussions to the U.S. dollar could be staggering, that’s a considerable amount of additional Treasury Securities the government will have to issue in order to fund that debt.  Added to the fact that the U.S. hasn’t had a government surplus in decades could potentially degrade the credit worthiness of Treasuries in the eyes of foreign investors.

All this taken together spells bad news for the long term standing of the dollar.  Some of it’s effects can already be seen with the slight rebound in the price of oil after the latest bailout was announced.

What we already thought were high commodity prices over the past year could balloon out of control if the dollar hits new record lows as some currency experts are predicting.  The inflationary pressures which have abated somewhat since the middle of summer could quickly return with a bang.

The recession that many economists have long predicted may now be unavoidable and it’s uncertain if the U.S. government will be able to spend it’s way out of this mess.