Market Update
Dwight Johnston
Vice President, Economic & Market Research
Money for Nothing?
In last month’s edition of Words from WesCorp, I cited Bernanke as being on record that he fears deflation much more than inflation. In years past, he has said that a fed funds rate near zero and other “quantitative” moves might be required to ward off an extended bout of deflation. This month, Bernanke stepped closer to making his “theoretical” moves reality. In a speech on December 1, Bernanke said the economy would remain weak for some time. He stated the obvious. The Fed doesn’t have much more room to cut the fed funds rate, but there are 100 basis points between 1 percent and 0 percent to play with. He also alerted the market to the thought the Fed might also purchase U.S. treasuries and agencies to pump more money into the system. That would accomplish the purpose of pumping more money into the system, but it fails to address the real problem—credit spreads.
The lone Fed action so far that did have an impact on non-treasury credit was the announcement that it would buy $500 billion in agency mortgage-backed securities. While agency backed MBS are still considered high quality, investors have been unwilling to add to positions. Thus, mortgage rates have refused to come down along with treasury rates. The Fed’s purchases will basically fund an entire years worth of production by the agencies. Although the Fed will not begin purchasing these securities until early next year, the announcement had an immediate impact on conventional mortgage rates. The Fed and Treasury need to take note of this modest success and get more creative with programs that will help lower credit spreads.
Going forward, banks and other lending organizations will continue to be constrained in lending that remains on the balance sheet. Losses will continue to eat into capital, and the TARP program will cover only a small portion. Banks need to have the ability to securitize loans again, but that asset securitization market has died along with any other credit-related market. Instead of creating more loan facilities, as the Fed has just done with the $200 billion ABS (asset-backed securities) program, the Treasury needs to offer a fee-based guarantee of securitized loan packages. That would create a new class of investors for securitized loans. The Fed has committed $8.5 trillion in various funding vehicles to solve the financial crisis, but only the $500 billion agency MBS purchase is directly aimed at reducing the cost of borrowing to the end user. The rest has been directed toward propping up the system. We hear constant talk from Bernanke and Paulson that we won’t follow the Japanese pattern of keeping failed enterprises on life support. Yet, that is exactly what we seem to be doing.
Finally, the National Bureau of Economic Research officially declared that the recession began in December 2007. The fact that it took them a year to declare a recession is pretty laughable and tells you how irrelevant these “official” pronouncements really are. We, and others, said early this year that the economy was in a recession for two simple reasons. Workers were losing jobs and people were having trouble paying bills. It didn’t take a year’s worth of research to figure that out. We hope the Fed doesn’t go another year before figuring out that propping up zombie companies is not an effective strategy for growth.
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