For the second time this year, Federal Reserve Chairman Ben Bernanke has told Congress that the economy needs the help of a stimulus package to get back on its feet. His support for a new spending package came in testimony before the House Budget Committee on Monday.
Bernanke is concerned that the U.S. economy is poised to be weak for "some time," and unless it gets some sort of shot in the arm to inoculate it against the current financial crisis, the slowdown will be brutal.
"The uncertainty currently surrounding the economic outlook is unusually large," Bernanke said, referring to the investor nervousness that has rocked the stock market and frozen credit in recent weeks.
The prospect of a stimulus package and the first hints of a thaw in the credit markets buoyed investors on Wall Street. The Dow Jones industrial average ended 413.21 points higher at 9,265.43.
Analysts are breathing a sigh of relief as U.S. investors seem to be back to trading on fundamentals like earnings instead of herdlike panic and a rush to the exits. Markets in Europe and Asia set the tone for the new week. Investors there were cheered by the decision by the Netherlands to inject $13.4 billion into banking and insurance giant ING. Germany also announced that it was working on a rescue package should any of its banks get into trouble.
Among the good news numbers that cheered U.S. investors: The London Interbank Offered Rate, known as LIBOR, has started to respond to the huge infusions of cash that governments have pumped into the global financial system.
LIBOR is the interest rate U.K. banks charge each other to borrow money, and it is set by a survey of 16 British banks. Right now LIBOR is at 4.059 percent — up from about 2.5 percent before the crisis began. Lots of debt, including mortgages, is tied to LIBOR, so it is a good yardstick with which to measure efforts to save the financial industry. Wall Street is anticipating LIBOR will dip below 4 percent soon, and it sees that as a good harbinger of things to come.
Rep. Barney Frank of Massachusetts, chairman of the House Financial Services Committee, will hold hearings Tuesday aimed at sketching out the parameters of a new stimulus plan. He told CNBC Monday afternoon that the plan would need to be more than 1 percent of GDP. While some analysts had discussed a $150 billion stimulus plan, he says the package will have to be much bigger than that. The talk on Capitol Hill is that it is more likely to be in the $300 billion range.
"If we do not do this kind of stimulus, the deficit will get worse because of the loss of economic activity," Frank told CNBC when asked whether this kind of spending will just blow a hole in the already ballooning deficit. Speaking broadly, Frank said he envisioned a plan that would include some sort of relief to states, money for infrastructure projects that are already on the drawing board, and middle-class tax relief.
Another Shot In The Arm
Democrats in Congress have been agitating for a new stimulus. The Bush administration has been lukewarm to such a plan but came out and said it was open to the possibility shortly after Bernanke's testimony.
"If the Congress proceeds with a fiscal package, it should consider including measures to help improve access to credit by consumers, homebuyers, businesses and other borrowers," Bernanke said. "Such actions might be particularly effective at promoting economic growth and job creation."
The Fed has already tried to goose economic growth by lowering interest rates. On Oct. 8, as part of an unprecedented global cut, the Fed dropped the overnight federal funds rate — the interest rate at which banks lend to each other — to 1.5 percent from 2 percent. Wall Street investors are expecting another rate cut when the Fed's Federal Open Market Committee meets in Washington on Oct. 28-29.
In making his case, the Fed chief provided a gloomy recitation of economic woes that have already occurred. The economy shed 168,000 jobs in September, bringing the total job loss since January to nearly 900,000. That means unemployment has risen 1 or 2 percentage points since January. Bernanke said the housing market is also depressed. Single-family-housing starts dropped 12 percent in September.
"Residential construction is likely to continue to contract next year," Bernanke said.
In recent years, Fed chiefs have been focused on narrowing the budget deficit. So Bernanke's support of more spending is unusual. And while he conceded that there were trade-offs in spending more government money and adding to the debt, he said he still supported a package to help spark economic growth.
"With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Bernanke said.
There has already been a stimulus package from Congress this year. It enacted a $168 billion plan that included tax rebates for individuals and tax breaks for businesses last spring. There were rebate checks of up to $600 per person that gave the economy a boost, but not enough to see the economy through the current difficulties associated with the financial crisis. All indications are that consumers are pulling back again.
Even when questioned directly by the committee members about what a package should include, Bernanke offered only generalities. He said that the package would need to be timely, well-targeted and would have a limited effect on the government's budget deficit — which is rocketing. Bernanke suggested that a package would do well to include provisions that would help ease wariness in the credit markets.
"The credit constraints really are hitting home," Bernanke said, reciting a litany of credit problems — from businesses having trouble getting money to consumers unable to get car loans — that are putting the brakes on economic growth.
Paulson Sees U.S. Making Money On Bailout
Treasury Secretary Henry Paulson tried to add to the loosening of credit markets by providing more details Monday on how the government will go about buying a $250 billion equity stake in the nation's banks. The program is meant to be a straightforward way to beef up thinning bank reserves and inspire confidence so banks start lending again. So far the results have been mixed, as banks are still wary about whether the program will work.
Paulson announced a streamlined application process for banks. He said that banks would just need to fill out a two-page form and return it to their primary regulator. The regulator will review it and then forward it to the Treasury Department. Treasury will make the financial decision on which institutions will receive the stock purchases. Banks have until Nov. 14 to apply.
Paulson tried to make the case that the program was already doing some good and would enjoy lots of participation. He said in addition to the nine large banks that announced their participation last week, a roster of other banks large and small have said they want to participate. Citigroup, Goldman Sachs, Wells Fargo, JPMorgan Chase, Bank of America, Merrill Lynch and Morgan Stanley are among the institutions that will be first in line for the government infusion.
"Our purpose is to increase confidence in our banks and increase the confidence of our banks, so they will deploy, not hoard, their capital," said Paulson. "And we expect them to do so, as increased confidence will lead to increased lending."
Many banks have been running on fumes, working with less money because of their bad bets on mortgage-related investments and hoarding the cash they have against more bad news in the future. While Paulson has tried to portray the Treasury's decision to buy stakes in banks as a voluntary program, there has been more than a little arm-twisting behind the scenes.
When Paulson met with key banking executives at the Treasury last week, he presented them with a bit of a fait accompli. He said they had to accept government investments even if they didn't think they needed them. Paulson told them it was their patriotic duty to do so. The idea was to include healthy institutions in the recapitalization program as well as ailing ones so that banks that chose to accept the government's help wouldn't be stigmatized or seen as failing.
Paulson said the government would end up making money on the stakes it would take in the banks. "This is an investment, not an expenditure," he said. "There is no reason to expect this program will cost taxpayers anything."
The last time the Treasury waded into the banking system in this way was in the 1930s. That's when the government set up the Reconstruction Finance Corp. to make loans and buy stakes in distressed banks during the Great Depression. The price tag at the time: $1.3 billion. The government eventually got out of the banking business when the economy stabilized. The government sold the stock it held to private investors and the banks themselves. That's expected to happen in this case, as well.
Investigations Into Credit Default Swaps
New York state and federal prosecutors are wading into the financial crisis in a new way as well. They are investigating trading in credit default swaps — insurancelike securities that have been at the core of the financial crisis. Investigators are looking at whether traders manipulated the swaps to drive down the price of financial shares over the past year. The investigation was first reported in The New York Times and was confirmed to NPR by law enforcement officials.
Credit default swaps were supposed to protect buyers from people who ended up defaulting on debt. A lot of these swaps were meant as a hedge against the bundles of mortgage-backed securities losing value. The cost of the protection, also known as a spread, rises when investors grow more concerned about the viability of companies. Spreads on the swaps tied to debt issued by financial institutions like Lehman Brothers, Morgan Stanley and others began surging in the spring. That led to a decline in the companies' share prices partly because the cost of protecting their debt was going up.
New York Attorney General Andrew Cuomo and the U.S. attorney in Manhattan, Michael J. Garcia, are looking into the practice. The Securities and Exchange Commission is also looking into credit default swaps. The credit default swap market has been unregulated because it fell somewhere between being a security and being insurance. There are moves afoot now to bring them under the SEC's umbrella.
Subpoenas Issued In Lehman Probe
Separately, law enforcement officials said that 17 subpoenas have gone out to executives with links to Lehman Brothers as part of an investigation into the investment bank's collapse. News of the subpoenas first broke over the weekend. During this financial crisis, FBI probes have become almost a matter of course. Law enforcement officials say that in some cases, they are looking into these collapses just to ascertain that no crime was committed.
Lehman CEO Richard Fuld is among the people under subpoena. The subpoenas in no way suggest guilt. They are just a means of obtaining more information. U.S. attorneys in Manhattan, Brooklyn and Newark, N.J., are all investigating the company, and it is unclear whether some Lehman officials have been subpoenaed by more than one of the investigating grand juries.
Lehman sought bankruptcy protection last month, saying it was $613 billion in the red. It is one of a number of financial companies in the FBI's cross hairs. The FBI has declined to publicly name names when it comes to these investigations, but the FBI keeps revising the number of institutions it says it is looking into.
Most recently, FBI Director Robert Mueller has said his agency is investigating more than two dozen large financial institutions, though he hasn't been more specific than that. Privately, FBI officials have told NPR that any of the large companies that have had to declare bankruptcy or have had financial difficulties in recent weeks are likely to be targets of some sort of investigation — if only to assure law enforcement that no fraud has taken place. The Lehman investigation was announced some time ago.
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