The financial world changed last week, and no one noticed. No one, that is, except policy-makers in the Bush administration and Congress, and the free-wheeling investment bankers whose favorite pastime once was trumpeting the virtues of red-in-tooth-and-claw capitalism.
On Thursday, staffers from the Federal Reserve Board descended on Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers to check into their liquidity and solvency — who they are lending to, who they are trading with, how much capital they have or can get quickly. It seems that all of the major investment banks, with the possible but not certain exception of Merrill (it won’t say), have availed themselves of the Fed’s new open-handedness.
Thanks to deregulatory measures passed by Congress in 1999 at the urging of John McCain’s top economic adviser, then-Texas Sen. Phil Gramm, until now no such supervision was deemed necessary. But that was then, and this is now. The post-Bear Stearns world is one in which the Fed greased the wheels for a JPMorgan takeover by arranging for taxpayers to accept the risk of $29billion in loans on Bears’ books in exchange for cold, hard cash. More important, Federal Reserve Board Chairman Ben Bernanke has agreed to be the cashier of last resort for other investment banks, which obliges him to check into just how his new debtors do business.
More changes are in store. Americans bedeviled by more debt than some can handle are about to receive the Senate’s version of a lifesaver. Its exact contours are unclear, in part because Congress is not exactly certain how to balance its desire to relieve homeowners’ suffering against the danger of rewarding imprudent lending and borrowing. Nor is it sensitive to the law of unintended consequences.
Remember, it was Congress that passed the Community Reinvestment Act, requiring the Fed to force banks to increase lending to poor ghetto-dwellers (“underserved communities” in the language of the act) who wanted to buy homes. Enter the subprime mortgage problem.
Now we are to have Christmas in April, or May at the latest. But bipartisanship can be expensive. Senate Democrats got $100 million to provide counseling to at-risk homeowners, and $4 billion in grants to communities to buy and refurbish foreclosed properties. Republicans’ gift list includes homebuilders, who will get $6 billion in tax breaks. Throw in authorization for the states to issue $10 billion of bonds to fund the refinancing of existing homes and purchases by first-time homebuyers, authority for various government agencies to increase their backing for a variety of mortgages, and a $15,000 tax credit for anyone buying a residence facing foreclosure, and you have a merry April for lots of people. With even more goodies to come.
But unless Congress and the administration find a way to put a floor under house prices (and perhaps even then), the cure is notgoing to be concocted in Washington. It will come in part from the recapitalization of the investment banking industry made easier by Fed guarantees, in part from the restoration of confidence following the deleveraging of the industry as the Fed’s auditors gradually prohibit the inverted pyramid on which Bear Stearns was built: $34 of debt piled onto every $1 of capital. But mostly it will come as banks — encouraged by the fact that the huge UBS write-down was followed by a rise in the price of its shares — come clean and get their balance sheets more in line with reality.
So much for the financial sector. The so-called real economy remains in, or so close to, recession that Bernanke finally used the R word. The economy has lost 252,000 non-farm jobs since the beginning of the year, and the unemployment rate has risen from 4.9 percent to a still relatively low 5.1 percent. Sales of passenger vehicles are at their lowest level in a decade, the manufacturing sector is slowing, and consumers are cautious.
But Bernanke’s statement that “there’s a chance that for the first half as a whole, there might be a slight contraction” is hardly a forecast of the end of the economic world as we know it. The manufacturing sector is shrinking, but only slightly. And consumers, who account for 70 percent of the economy, might not be increasing their spending, but neither are they cutting back. That might come, but so might a boost from the stimulus checks that will soon be in the mail and the delayed effect of the Fed’s interest rate cuts.
So be worried, but not very.
