Federal Reserve & Interest Rates

In a speech today, Treasury Secretary Henry Paulson called for new regulations to help liquidate failing firms without it affecting overall market stability.

“For market discipline to constrain risk effectively, financial institutions must be allowed to fail,” Paulson said in excerpts of a speech he will deliver in London.

“It is clear that some institutions, if they fail, can have a systemic impact, so we must give regulators the authorities to limit that impact and facilitate an orderly failure,” Paulson said.

Why are these regulatory changes needed?  Well back in March, the Fed intervened when it looked like Bear Stearns was in danger of failing, financing a buyout from JP Morgan and putting to risk potentially $30 billion in taxpayer dollars.

Through it’s excessive risk taking in the residential mortgage market, Bear Stearns deserved to fail but it couldn’t be allowed to due to the impact it would have on other financial firms.  Financial firms are tightly interconnected these days through counterparty risk in the credit derivatives market, a largely unregulated market that has had explosive growth in the past decade. 

It is a massively leveraged market that has the potential of causing financial Armageddon according to some well known industry leaders.  Although firms are slowly de-leveraging, there will still be the potential of a failure cascade as the credit crisis is far from over. 

Over the past few weeks speculation has run wild on Wall Street that Lehman Brothers would meet the same fate as Bear Stearns and need to be sold at a discount, although those rumors have abated somewhat recently.  While this is one potential trigger that has been avoided, the danger will likely exist as long as home prices keep falling and firms face the prospect of more writedowns.

The Commerce Department revised their estimate’s on GDP numbers for the first quarter in a report released today.   

The 0.9 percent gain at an annual pace in gross domestic product compares with an advance estimate of 0.6 percent, the Commerce Department said today in Washington. Fourth-quarter growth was 0.6 percent. Separate figures today showed the number of Americans continuing to receive jobless benefits rose to a four-year high this month.

Investors took that as a positive sign that the economy is remaining resilient despite the ongoing problems in the housing and credit markets.  Many economists have been predicting a recession for the U.S. economy and while growth has slowed considerably, it still remains in positive territory.

The unexpected rise in GDP has been attributed to the rapid growth of U.S. exports which is benefiting quite nicely from the decline of the dollar.  While the U.S. is still running a trade deficit, it’s has fallen to lowest level in six years.

Americans have also cut back on their consumption of imports, the prices of which have risen sharply over the past year.  While domestic purchases have increased, consumer spending has slowed which has dragged down economic growth.

If unemployment figures can remain stable for the upcoming quarters it may be possible for the economy to stay out of a recession.

The economic stimulus money is going to start going out to consumers today.  This is a bit earlier than planned, as it was supposed to begin in May.  Direct deposits will be issued starting today, and all of those receiving tax rebates by mail will receive them after May 9, 2008.  This is a week earlier than originally planned.

The original intent of the economic stimulus package was to boost consumer spending, which would ultimately give the economy a boost.  After all of the inflation in commodities like food and gasoline, this package could end up covering additional expenses, rather than offering extra savings.  The price of oil is continuing to rise steadily, and $4 per gallon looks to be a strong possibility this summer.

The economic stimulus package will vary from household to household.  Single individuals who earn at least $3,000 last year should receive $600.  Married couples will be given $1,200.  There will also be $300 alloted to dependent children. Only those who filed a 2007 tax return as required are eligible.  Individuals who don’t have to file are also eligible.  The IRS has set July 11th as the deadline for all rebates to be received by consumers.  Those who filed a late return may have to wait longer.  Individuals earning more than $75,000 and married couples earning over $150,000 will no be receiving any of the stimulus money.

Additional money will temporarily help most individuals who are having minor financial problems while budgeting against inflation.  It can also provide some relief for unemployed individuals.  Most consumers will probably be using the money to help pay debts or save the money for future bills.

Bush admits to economic slow down, but will not call our economic state a recession.  Economists disagree with that assessment.   We are in a recession.  Some might call it tough times, but, I am pretty sure this is a recession.

Use the money to your advantage.  If you have debt, put the money towards that.  If you are struggling with rent, grocery bills, or gas, use the money for that.  If your bills are caught up and you aren’t having a hard time with inflation, put the money in an interest bearing account and use it when inflation starts to hit you.  Sooner or later, the way things are going, you will have to use the money.  Spend it wisely.