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Following the appearances and sometimes conflicting statements of President Bush, Congressional leaders, the Fed Chairman, Treasury Secretary, FDIC and SEC heads, the beggar pleas of the auto big three, and parade of President-Elect Obama’s appointees, I begin to feel I am watching “As the World Turns.” I might be amused were the stakes less serious. Drama aside, I will continue to focus on the financial crisis in lieu of my usual tax commentary because of the many developments the past two weeks since my last commentary.


1. We are in a recession: Economists have finally figured out what every common person has known, that times are bad. Economically speaking, the U.S. economy has been in a recession since December 2007 they now report. Some other dour third quarter or later months economic indicators reported are:

a. Employment: In November alone 500,000 people were laid off from jobs. This was the steepest one month drop since 1974. In total, this year 1.9 million workers have been laid off this year. Job loses are happening around the world. In China the decline in availability of city jobs has begun a wave of reverse migration to rural areas and raising concerns about social unrest.

b. Manufacturing: U.S. manufacturing activity declined to a 26 year low.

c. Commodity prices: Mirroring the worldwide manufacturing slowdown, commodity prices for zinc, copper and lead have seen the bigger declines than in 1929.

d. Evidence of continued risk aversion: A measure of continued risk aversion is found in the widening gap or spread between the so called risk free or benchmark Treasury debt yields and those on debts of others. Even 10 year municipal bonds are yielding 4% or more than 1% over the 10 year Treasury obligation. Thus, the cost of borrowing by local governments, companies and others is increased creating a drag on the economy. Recently, the NY Port Authority received on bids when it offered $300 million in taxable 10 year notes. Its long term debt has been rated Aa3 by Moody’s but investors now aren’t biting on any obligation rated less than double-A or triple-A.

e. Housing: Nationally housing prices continue to decline and in Florida the third quarter saw 90,000 homes added to those already in foreclosure. The FHA, as discussed in my last update, has been insuring more loans and taking on more risk. Its reserves have fallen to 3% from 6.4% of insured loans (the congressional mandate is 2%).

f. Consumer spending: Despite a decent Black Friday, November sales tallied by 37 major retainers were the worst since 1969. Sales numbers will likely grow worse as the impact of job losses is felt. Shoppers appear to have been more frugal and focused. The mantra no longer is “shop ‘til you drop” but “just what you must.” Cyber Monday (Monday after Thanksgiving), against that trend, showed a 15% increase in on-line purchases following step price discounts.

g. Problem banks: FDIC reports that its watch list of problem banks had risen from 117 to 171. Undoubtedly, the list will grow longer as the impaired value of bank held assets becomes clearer.

h. The dollar: The dollar continues strong against most currencies except the yen, reflecting continuing fear in world markets, growing economic uncertainly and fear of political instability often following economic crisis.


1. The government players: In my last update I’d compared the government’s efforts to the game of “Chutes and Ladders” but I didn’t mention the players. It is important to understand that there are different sources of bail out funding, namely:

a. The Federal Reserve or Fed: The Fed is America’s central bank created in 1913 and charged with controlling our money supply. The Fed, presently chaired by Ben Bernanke, employs various tools to increase the supply of money or market liquidity when needed:

i. Cost of borrowing: The Fed lowers the benchmark rate it charges and thereby, in theory, lowers the cost of borrowing for everyone making loans easier to qualify for and reducing the cost of funds. The Fed has already steeply lowered the Fed Funds rate now almost at zero and has limited room to impact monetary policy with this tool. This tool may have helped prevent the economy from collapsing but it has not been the cure all.

ii. Quantitatively increasing the supply of currency: The Fed in effect prints or creates new money. It has been using its cash reserves to make loans and recently even to purchase assets of Fannie Mae, Freddie Mac and others to the tune of $600 billion in any effort to lower mortgage rates. The rate for well qualified borrowers has fallen to 5.5% resulting in a crush to refinance existing loans. But, since only well qualified borrows are being considered by banks, the Fed’s program is unlikely to stem the tide of home foreclosures. The Fed’s loans and asset purchases have amounted to over $1.35 trillion since August of 2007 increasing its holdings to $2.2 trillion. Increasing the money supply is inflationary but right now the concern is more with falling prices and possible deflation combined with stagnation or recession.

b. The U.S. Treasury: Unlike the Fed, Treasury Secretary Paulson must borrow money to implement the Treasury’s bail out programs. Congress had authorized $700 billion for the TARP program about one half of which has been spent. The TARP program is but a small part of the $7.76 billion that has tabulated to have already been spent or promised. What is the Treasury now up to?

i. Buying Treasury obligations: The Treasury hopes to reduce mortgage rates by buying Treasury bonds. It has targeted a mortgage rate of 4.5% which it hopes will spur home-buying. Its action, if implemented, may lower rates but once again the Treasury is focused on liquidity when already the Fed and Treasury have swamped the markets with cash. The credit crunch is less not due to a lack of funds than to these factors:

1. Willingness of banks to lend to only the most qualified borrows with substantial equity.

2. Continuing decline in home prices increasing the number of upside down mortgages and further restricting bank’s proclivity to assume the risk of further declines in collateral.

3. Worsening job market increasing foreclosures. It is expected that 5.2 million homes will go into foreclosure through 2010.

ii. Endgame: Eventually, the government will have to step in to acquire and refinance delinquent and imperiled loans to quell the tide of home value ownership slippage and homeowner evictions at the crux of our economic ills.

iii. Company rescues: The list of companies that as President Bush said are “too big to let fail” has grown AIG to include Bear Stearns, Fannie Mae and Freddie Mac and Citicorp. Some have wondered aloud if the government has an exit strategy for its bout of what psychiatrists might call “over-reactive rescue disorder” or “rescue-itis.” These are my labels but not my view about the necessity of federal intervention which I believe to have been necessary. The question is who will be next, apart from the auto big three?

iv. Factors hindering Treasury effectiveness: The transition to a new administration has impacted on the Treasury’s staff and made it more difficult for Paulson to implement and oversee programs. Congressional debate has also created uncertainty whether congress would now approve use of the remaining $350 billion of the TARP fund.

c. Congress: Congress holds the purse strings on government spending and therefore can impact the markets with fiscal policy. To pay for its programs congress must either borrow money or collect taxes.

i. President-elect Obama has proposed, among other programs, a large infrastructure spending program but this will take time to get under way and there is no consensus on how effective it will be in stimulating economic growth.

ii. The Neighborhood Stabilization Fund administered by HUD is injecting $4 billion into 308 cities for various projects, but sprinkling the funds over many cities, to be fair, has diluted its impact.

iii. The impact of the lame-duck Congress has been circumscribed for lack of a consensus as to what should be done next.

2. Actions aimed at restoring confidence: Consumers have been battered by the loss of home value, decline in retirement savings and household wealth, job insecurity and a general discomfort about the government’s programs to redress these problems. The government has taken steps intended to bolster confidence, some of which are:

a. The Treasury guarantee of mutual fund money market accounts has been extended from 12/18/08 to 4/30/09.

b. Treasury will insure that investors in the Prime Reserve U.S. Government Fund, which had fallen below $1 in value, will receive $1 per share on liquidation by becoming the buyer of last resort for its assets.

c. FDIC continues through 12/31/09 to insurance bank accounts up to $250,000 instead of the normal $100,000.


There is growing pressure on congress and President-elect Obama to precipitate some additional response to the crisis before January 20, 2009. It now seems likely that some interim relief or bridge loan will be provided to the auto companies before the end of the year. Beyond that I think we will continue to roll from urgency to urgency with ad hoc government reactions being the rule of each new day. It has become astonishingly clear to me, however, that we are experiencing an extraordinarily rare seismic and systemic change in our national financial structure that will, for a long time to come, alter how business is conducted and which survive or fail, how consumers spend or save and how intensely government regulates. We will all have to adjust our attitudes in the coming new financial world.

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© 2008 by Robert S. Steinberg, Esquire, Miami Florida
Articles and consultations authored by attorney reflect the state of law as of the date of their writing. The laws change daily. Users of this site are advised to consult attorney regarding their situation.
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