Rescue plans with side-effects
30-3-2009 | Economic news
In the first quarter of 2009, we have seen large rescue plans to jump-start the US financial system and economy. US economist Philip Marey from Rabobank’s Financial Markets Research department, discusses the effects of these rescue plans.
Geithner’s invitation to investors
On 23 March, Treasury Secretary Geithner announced his plan to deal with ‘toxic’ assets that plague the financial system. A sustainable recovery of the economy is not possible unless this problem is solved. The Treasury provides US$75 billion to US$100 billion to match equity put up by private investors to buy toxic assets. Moreover, the FDIC provides guarantees for the debt issued by investors to finance the purchase of toxic loans, and the Fed opens a credit facility for investors who are willing to buy toxic securities. This program should generate US$500 billion to purchase toxic assets.
However, the question is whether Geithner’s plan offers investors enough incentives to start buying toxic assets, something they have not been willing to do so far. Besides the price risk of toxic assets, participating in this program also leads to political risk, since recent political reactions to executive compensation and bonuses may deter investors from being subject to political scrutiny.
Obama’s economic stimulus package
Meanwhile, rescue plans for the real economy have already been put in place. In February, president Obama signed a US$ 787 billion economic stimulus bill that – in combination with the ‘inheritance’ from the Bush administration – will lead to a US$1.75 trillion budget deficit in 2009. The sky-rocketing deficit is generating a massive supply of Treasuries in the market, leading to upward pressure on long-term interest rates.
As for its impact on the economy, the Obama administration intended to use the stimulus package to give the economy a strong impulse by focusing on ‘shovel ready’ infrastructure projects. However, conflicting political interests in Congress watered down the final stimulus bill to a heterogeneous package with an impact that will be smoothed out over 2009 and 2010. That meant an end to Team Obama’s ambitions for a Big Bang to boost the economy out of recession.
Bernanke’s Big Bang
Instead, on 18 March, the Big Bang came from the Fed when it decided that this was the right time to use the ultimate weapon in its arsenal, the purchase of longer-term Treasuries, despite the inflationary fall-out that we may see down the road. The Fed’s demand for Treasuries and additional purchases of agency securities should reverse the upward pressure on long-term interest rates in the coming months, which would help the economy. However, once the economy recovers, substantial inflation pressure may arise, while a timely reversal of the purchases of longer-term Treasuries may be difficult to achieve and could even hinder the recovery because of the upward effect on interest rates.
The unprecedented measures that the US has taken in recent months are necessary to bring an end to the credit crisis and the economy back to life, but they may lead to new problems down the road: high inflation and interest rates, and a loss of confidence in US fiscal and monetary discipline and the dollar.
Financial Markets Research (FMR) is the research department of Rabobank International’s Global Financial Markets division and Philip Marey is the author of this article.
