Why the Fed bailout might not work

There are so many reasons why the bailout won't work. Here are some specifics about the flaws in the current bailout plan.

Harry

Why the Fed bailout might not work

The announced plan to make credit markets more liquid could end up having the opposite effect.
By Peter Eavis, senior writer

NEW YORK (Fortune) -- The Federal Reserve's latest move to make credit markets more liquid could deepen problems in the banking system and actually cause the markets to be even more illiquid.

Wednesday, the Fed, along with other central banks, announced a plan that is designed to enable banks to borrow money directly from the Fed at below-market rates. This will allow a wider range of banks to access Fed credit, and simultaneously allow them to submit a broader range of collateral to the Fed when taking out those loans.

Why do this now? The Fed explained in a release Wednesday: "This facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress." In layman's terms this means that rates on loans between banks - measured by something called the London Interbank Offered Rate, or Libor - are too high for the Fed's tastes, so it is now prepared to itself lend to banks at much lower rates.

Before this move, banks could borrow directly from the Fed through the so-called discount window, at 4.75 percent. The key Federal funds rate is lower, at 4.25%, but that is open to a narrower range of financial institutions and accepts a narrower range of collateral than the discount window. The new program - called the Term Auction Facility (TAF) - will auction funds to banks at rates very close to the lower Fed funds rate. The first TAF auction, for $20 billion, is scheduled to begin on Dec. 17.

The potentially dangerous aspect of the TAF is that it will allow banks with problems to borrow their way out of trouble, rather than by taking measures like issuing large amounts of stock to bolster their balance sheets. Struggling banks are struggling chiefly because they were mismanaged and wrote too many risky loans when credit was cheap. The TAF potentially gives mismanaged banks even more cheap credit, which will delay a much-needed restructuring of the banking sector. Nervousness about banks could then deepen, leading to even fewer loans being made.

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The Fed's tightrope act

It's a long way down with no net. It may just take one more gust of wind and it's down down down.

Harry

The Fed's tightrope act

The banking industry is in a quagmire but the economy really isn't in that dire shape. And inflation is still an issue. What's Ben Bernanke and company to do?

See all CNNMoney.com

By Paul R. La Monica, CNNMoney.com editor at large

December 13 2007: 1:02 PM EST

NEW YORK (CNNMoney.com) -- The financial services industry is reeling due to exposure to bad subprime mortgage loans. But some market observers suggest that the rest of the economy is still in relatively decent shape, which could mean that the Federal Reserve may not cut interest rates that much further in 2008.

On Thursday, the government reported that the Producer Price Index, which measures wholesale prices, rose 3.2 percent, the biggest jump in 34 years. To be sure, much of this increase was due to soaring oil prices.

But the so-called core PPI number, which excludes volatile energy and food prices, rose 0.4 percent, above Wall Street's expectations of just a 0.2 percent increase. This could be a sign that inflation is still a concern.

What's more, despite all the doom and gloom about the housing market, the Commerce Department reported Thursday that retail sales surged 1.2 percent in November. And even if you exclude sales at gas stations, which were obviously juiced by rising prices at the pump, sales were still up a healthy 0.6 percent.

Largest jump in 34 years for wholesale prices

Add this up and the Fed's two big announcements this week suddenly seem to make a lot more sense.

"It's clear that the economy's moderation in recent months has been relatively gentle. There has been no outright collapse," said David Resler, chief economist with Nomura Securities International. "The economy may be on the soft side, but that doesn't mean we're going into a recession."

The Federal Reserve cut two key interest rates by only a quarter of a percentage point Tuesday, a move that caused Wall Street to panic. The Dow plunged nearly 300 points.

Many investors were hoping for a half-point cut, or at the very least, a half-point cut to the discount rate, which is what it costs banks to borrow directly from the Fed. But Wednesday, Ben Bernanke & Co. saved face somewhat by announcing a plan to inject billions of dollars into the banking system.

In conjunction with several other central banks in Canada and Europe, the Fed said it would conduct four auctions in the next month that will allow banks to bid for loans. Sources said it will probably cost banks less than the 4.75 percent discount rate to borrow money this way.

The combination of a mild rate cut and the new auction system seems to indicate that the Fed is looking for a creative way to solve the credit crunch on Wall Street rather than by simply slashing interest rates.

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Wholesale inflation surges to largest amount in 34 years

The past two days the Fed has taken further steps to prevent a deepening downturn in the economy (see here). These actions have push the dollar lower and therefore help to raise oil prices (and as we learn today other prices are sure to rise even more).

It is the Fed's mandate to be vigilant in the fight of inflation. Stable prices are a must in an orderly economy. The Fed has maintained that core inflation is in check and therefore they've continue to lower interest rates (now to a the lowest point in 2 years) and in addition pump money (see here) into the market to both prevent a recession (or worst) and to jump start the economy.

Now with the signs of inflation so blaring, the Fed will have to tread much more carefully in their next actions. Further cutting of interest rates or injecting billions of dollars of liquidity into the system my be the trigger to spark a vicious spiral of inflation. With housing down in the dumps, a recession PLUS inflation would be a nightmare economic scenario.

Harry



By MARTIN CRUTSINGER, AP Economics Writer 2 hours, 54 minutes ago
WASHINGTON - A record jump in gasoline prices pushed wholesale inflation up by the largest amount in 34 years. Still, shoppers stormed the malls in November, giving retail sales their biggest gain in six months.

The Labor Department said Thursday that wholesale prices soared by 3.2 percent last month, propelled by a record 34.8 percent rise in gasoline costs.

Even outside energy, inflation pressures emerged. Core inflation, which excludes energy and food, posted a 0.4 percent rise in November, double what had been expected.

Meanwhile, the Commerce Department reported that retail sales jumped by 1.2 percent last month, double the gain economists had expected. It was the biggest increase in six months and followed a much weaker 0.2 percent rise in retail sales in October.

The big rise in inflation demonstrated the pressures facing the Federal Reserve, which is trying to combat a sharp slowdown in economic growth while at the same time making sure that inflation does not get out of hand.

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Fed and Friends: Games People Play

Just a few months ago the Fed Chairman, Bernanke, said this would only be a $50 Billion problem. Then it was maybe $100 Billion...then $150 Billion...now $170 Billion+?!?! We are in the 1st inning of a long 13 inning game.

Those Fed rate cuts along with the Fed and other central bankers worldwide are causing the highest inflation in nearly 20 years. Did it help or hurt? Clearly it is not helping the foreclosures or the value of the money (what you may have left!) in your bank account.

Greenspan said yesterday it won’t be over until homes sell. Prices need to plunge to 50% less or we all need to get 50% raises. What!?!? Obliviously, there will need to be a further 'correction" in home prices, BUT stating for the record that 'prices need to plunge to 50% less...' is defeating all the measures that are suppose to circumvent or at least minimize the potential economic carnage from the housing and sub-prime disaster. If I were a potential home buyer and I hear this coming from our leader at the Fed...well, I think I'd wait a while before jumping in the market. And surely that is exactly what is happening.

Harry

Fed and Friends: Games People Play

9:36:48 AM December 12th, 2007

Now that I’ve got your attention. This isn’t a game. (Or is it?) But the Fed’s joint action with friends from around the world shows several things.

First, it shows why the Fed was so comfortable not cutting rates more than a quarter of point, which as I pointed out yesterday gave the initial impression that it wasn’t kowtowing to Wall Street. Well, it wasn’t kowtowing because it didn’t have to: It knew this was coming — a Wall Street pleaser, for sure — which makes you wonder whether there would’ve been a half-point cut, after all, if this bag-o-tricks wasn’t already in its hip pocket. (Otherwise, why not announce this yesterday, or the day before, or the day before that?)

But let’s take this a step further, to point two: If the Fed needed a little help from its friends, of vice-versa, wouldn’t that suggest that the situation we’re seeing is far worse than even we know? From what I can tell, this kind of action isn’t done willy-nilly. This credit crunch is a world-wide event. Lots-o-mortgage-and-other-loan junk stuffed in lots-o-smart-guy-portfolios here, there and everywhere.

The beat goes on…

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America's vulnerable economy

America's vulnerable economy

Nov 15th 2007
From The Economist print edition

Recession in America looks increasingly likely. Can booming emerging markets save the world economy?

IN 1929, days after the stockmarket crash, the Harvard Economic Society reassured its subscribers: “A severe depression is outside the range of probability”. In a survey in March 2001, 95% of American economists said there would not be a recession, even though one had already started. Today, most economists do not forecast a recession in America, but the profession's pitiful forecasting record offers little comfort. Our latest assessment (see article) suggests that the United States may well be heading for recession.

Granted, GDP grew by a robust 3.9%, at an annual rate, in the third quarter. Granted also, revisions may well push this figure up. But that was the past. More timely signs suggest that the economy could stall in this quarter. By early next year, output and jobs could be shrinking. The main cause is the imploding housing market. Experts said that house prices could never fall nationwide. But fall they have, by 5% in the past 12 months. Residential investment has collapsed, but a glut of unsold homes means that prices have much further to drop. Americans' spending is likely to be dented much more by a fall in house prices than it was in 2001 by the stockmarket's collapse. With house prices lower and credit conditions tighter as a result of the subprime crisis, households can no longer borrow against capital gains to support their spending.

Dearer oil is set to squeeze households further (this week's drop in crude prices notwithstanding). Consumer confidence has already fallen sharply. It cannot be long before consumer spending stumbles, which in turn would hurt companies' profits and investment. The weak dollar will boost exports, but at only 12% of GDP, exports are too small to make up for a weakening of consumer spending, which accounts for 70%.

I want to break free

Will an American recession drag the rest of the world down with it? The economies of Europe and Japan rebounded strongly in the third quarter, but look likely to slow down. Although both should be able to keep chugging along, neither is likely to set any great pace. Strengthening currencies will hurt exporters in both places. Europe's own housing hotspots are cooling, and some of its banks have been sideswiped by America's subprime ills.

The best hope that global growth can stay strong lies instead with emerging economies. A decade ago, the thought that so much depended on these crisis-prone places would have been terrifying. Yet thanks largely to economic reforms, their annual growth rate has surged to around 7%. This year they will contribute half of the globe's GDP growth, measured at market exchange rates, over three times as much as America. In the past, emerging economies have often needed bailing out by the rich world. This time they could be the rescuers.

Of course, a recession in America would reduce emerging economies' exports, but they are less vulnerable than they used to be. America's importance as an engine of global growth has been exaggerated. Since 2000 its share of world imports has dropped from 19% to 14%. Its vast current-account deficit has started to shrink, meaning that America is no longer pulling along the rest of the world. Yet growth in emerging economies has quickened, partly thanks to demand at home. In the first half of this year the increase in consumer spending (in actual dollar terms) in China and India added more to global GDP growth than that in America.

Most emerging economies are in healthier shape than ever (see article). They are no longer financially dependent on the rest of the world, but have large foreign-exchange reserves—no less than three-quarters of the global total. Though there are some notable exceptions, most of them have small budget deficits (another change from the past), so they can boost spending to offset weaker exports if need be.

This does not mean emerging economies will grow fast enough to make up for the whole of a fall in America's output. Most of them will slow a bit next year: for instance, China's growth rate may dip to “only” 10%. So global growth will ease—which, after five years at an average of almost 5%, close to its fastest pace ever, it needs to do. But thanks to the vigour of the new titans, it will stay above its 30-year average of 3.5%.

A tale of two prices

The rising importance of the world's new giants will not only boost growth. It will also shift relative prices, notably those of oil and the dollar. And the consequences of this will be less comfortable for developed countries, especially America.

The oil price has risen mainly because of strong demand in emerging economies, which have accounted for as much as four-fifths of the total increase in oil consumption in the past five years. In past American recessions the oil price usually fell. This time it is likely to hold up. That will not only hurt the finances of Western consumers, but may also make the jobs of their central bankers harder, by combining inflationary pressure with economic slowdown.

The enfeebled dollar—lately in sight of $1.50 to the euro—would be weaker still without enormous purchases by central banks in emerging economies. This support is now waning. China and others are putting a smaller share of increases in reserves into the American currency. And Asian and Middle Eastern countries with currencies linked to the dollar are facing rising inflation, but falling American interest rates make it harder to tighten their own monetary policy. They may have to let their currencies rise against the sickly greenback, meaning they will need to buy fewer dollars. More important, as international investors wake up to the relative weakening of America's economic power, they will surely question why they hold the bulk of their wealth in dollars. The dollar's decline already amounts to the biggest default in history, having wiped far more off the value of foreigners' assets than any emerging market has ever done.

The vigour of emerging economies is good news for the world economy: for its growth, it has much less need of a strong America. The bad news for America is that this, in turn, may mean that the world also has less need of the dollar.

Kuwait Ditches Dollar

Kuwait Ditches Dollar

Lionel Laurent, 05.23.07, 5:20 PM ET

Americans may not understand their central bankers' seemingly morbid fascination with the threat of inflation, but Kuwaiti officials do. After four years of pegging the dinar to the sliding American dollar, the governor of the oil-rich emirate’s central bank declared on Sunday that he would opt for a basket of currencies instead, citing “inflationary pressure.”

Sheikh Salem Abdul-Aziz Al Sabah told the official Kuwait News Agency that the dollar’s decline relative to other currencies had “contributed to the increase in local inflation rates.” After a 0.4% increase against the dollar on Sunday, the dinar held steady on Monday.

The U.S. Federal Reserve has also frequently fretted about inflation, even while holding interest rates at 5.25%. Chairman Ben Bernanke has had trouble convincing regular Americans: a Bloomberg/ Los Angeles Times survey released last month showed that 60% of those polled actually predict a recession in the coming year.

But in the Arabian Gulf, prices have outpaced U.S. monetary policy. Inflation in Kuwait hit 5% in the first quarter of 2007, up from 3.9% in December 2006. High oil prices and comparatively low U.S. interest rates have contributed to upward pressures in the region.

Kuwait’s ditching of the dollar is one of a series of signs that the greenback’s decline is affecting its international primacy. In 2004, India and Japan declared their interest in diversifying their foreign currency reserves, and the following year China and Malaysia opted out of dollar pegs.

But the result could in fact be healthy for the American economy, even if it casts into doubt the planned fiscal and monetary harmonization of the six Gulf Cooperation Council countries by 2010. Although Saudi Arabia, Oman, Qatar, Bahrain and the United Arab Emirates have all stuck with the dollar peg, a shift away from the greenback could dent the current account surplus that represents 30% of the bloc’s gross domestic product.

“A declining dollar is one ingredient in a longer-term stabilization and reduction in the size of the U.S. trade deficit,” said Nigel Gault, an economist with the market analysis firm Global Insight.

Kuwait’s decision won’t redress the trade imbalance just yet: although it last year ran a current account surplus of $37 billion, only about 10% of the emirate’s imports come from the United States. And the new basket of currencies is likely to give the dollar a weighting of up to 80%.

But as part of the larger picture, the move away from the greenback towards other currencies was one step towards redressing the balance of imports and exports.

“It’s half the story,” said Global Insight’s Gault. “The rest of the story is slower growth in US spending. And hopefully faster growth in the rest of the world.”

Dollar Crisis: None dare call it 'conspiracy'

Dollar Crisis: None dare call it 'conspiracy'

by Hal Lindsey

Global Research, November 11, 2007

WorldNetDaily

Crude oil prices hit an all-time high this week, closing above $98 a barrel for the first time in history.

According to the AAA, many drivers in my home state of California are already paying more than $4 a gallon for regular unleaded gas. And in one town south of Big Sur, unleaded gas topped $5 a gallon.

The U.S. dollar is at an all-time low, even when compared against the hapless Canadian loonie. Five years ago, a loonie was worth 60 cents. Today, it's worth $1.12 and climbing.

Yesterday, WorldNetDaily reported that the Chinese are considering abandoning the U.S. dollar as their national reserve currency. WND quoted Craig Smith's assessment of the consequences of such a move by Beijing on our economy: "If that were to happen, all bets are off, and we will be in a depression that makes 1929 look like child's play, or we will experience Weimar Republic inflation as the dollar makes extreme moves toward devaluations."

On Tuesday, the U.S. national debt topped $9 trillion for the first time in history, according to the U.S. Treasury Department's daily accounting of the national debt. Nine trillion dollars! The number is so staggeringly high that it exceeds our ability to comprehend it in monetary units.

Million, billion, trillion – in financial terms, for most of us, it means a lot of money, really a lot of money, but that is about as specific a picture as most ordinary people can grasp.

Let's put all these "illions" into perspective. A million seconds is roughly 12 days, whereas a billion seconds is approximately 32 years.

We understand dollars. And we understand time. So it would take 12 days to pay back a million dollars at a dollar a second. But if you started right now, you'd pay back a BILLION dollars, at a dollar a second, in the year 2039.

A trillion seconds is roughly 32 thousand years. At a dollar a second, you'd pay back a TRILLION dollars in the year 34007.

The U.S. debt stands at $9 trillion. If my calculator is working, then at a dollar a second, the U.S. could be debt- free in the year 290007.

The point of that little exercise was two-fold. The first was to clarify the sheer volume of the debt; the second was to demonstrate the possibility that anybody in government really believes we can ever pay it off.

Each U.S. citizen's share of the national debt works out, according to the National Debt clock, to $29,947.50. That means the average American family of five owes, collectively, $149,737.50.

It also means that unless the average American family of five has a net worth of at least $149,737,50 in assets excluding liabilities (they don't), America is already bankrupt.

Over the past few years, there has been growing public concern about the emerging "Security and Prosperity Partnership" plan that some say is really a "deceptive roadmap" to a coming North American Union and a new, unified currency tentatively called the "amero."

The feds steadfastly deny such a plan exists, even as it opens the borders to Mexican truck traffic, widens the I-35 corridor from Mexico to Canada and, counterintuitively, refuses to tighten the borders with either Mexico or Canada, despite both logic and widespread public demand.

All of these things have brought me to believe that powerful forces outside of our government – like the shadowy international Money Trust members of the "Bilderberg Group" – made a decision to force the formation of the North American Union along with the amero. There decisions have been instituted in the past via the Trilateral Commission, which is the dba for the nefarious Conference on Foreign Relations. Destroying the American dollar could force the crisis that would force the creation of the North American Union. To quote the title of a book of the 1960s era, "None Dare Call It Conspiracy."

Ordinary Americans may not fully grasp just how dire the true economic picture is, but you can bet our leaders do. Yet from the White House to the Federal Reserve, nobody seems particularly eager to address the issue, preferring instead to talk about the "budget," as if the budget WERE the debt, rather than merely a measure of our ability to keep up with our payments on the debt.

It is almost as if they already have a Plan B in reserve, ready and waiting to be triumphantly introduced – just in the nick of time.

I wonder what it might be?