financial rescue plan is a necessary pre-condition for economic recovery

Discussion in 'Economics' started by aresky, Oct 1, 2008.

  1. aresky


    Tuesday September 30, 2008
    US likely to pump more funds into rescue plan

    SEVERAL prominent economists believe the amount budgeted - US$700bil - for the bailout of several large corporations, deemed too important for the US economy’s survival, may be the first tranche only.

    And once the fund gets the green light to be disbursed, there may be more to bail out other debt-ridden companies as they surface.

    According to British-based Schroders plc chief economist Keith Wade, this was a possible scenario and the figure bandied about is about US$500bil for the second tranche.

    After all, it didn’t seem too long ago when we first heard of mortgage giants Freddie Mac and Fannie Mae going bankrupt and, soon after that, a slew of other large corporations also came into the picture with the same problem.

    Keith Wade
    Wade said the market had pinned its hopes on the Troubled Asset Relief Plan (Tarp) as the way out of the crisis.

    “While we believe it directly addresses the root problem, which is ridding banks of their toxic assets, interest rate spreads should narrow and monetary policy should become more effective. However, even if Tarp does the job, depending on the price which is set for buying toxic assets, it may well imply further write-offs and, in some cases, bankruptcy as losses are crystallised,” he said.

    Wade said given the scale of the problem, there might be a need for Tarp 2 and markets would certainly need to brace themselves for more capital raising as banks restore their balance sheets to a position where they were willing and able to lend again.

    He also pointed out that Tarp only addressed the supply side of the problem while ultimately recovery would also require demand for credit to rise.

    “Falling house prices and rising unemployment suggest that households will not be rushing to gear up when the credit crunch eases,” he said.

    Wade expected the Federal Reserve (Fed) to cut rates by 50 basis points by end-October. Like most economists, he agreed that the key to recovery was with US Treasury secretary Hank Paulson’s proposed US$700bil Tarp.

    “There is little doubt in our view that by ridding the banking sector of its toxic assets, such a plan would help free up the system and start the credit mechanism working again. In this respect, it is a necessary pre-condition for economic recovery,” he said.

    Most economists agreed with the Fed’s bailout plan, that it was the right step to take.

    A local economist said to save the US banking system from going down, it had to unfortunately bail out these large corporations because they were intrinsically linked to the system.

    He also said the failure of rate cuts by the Fed to feed through to the real economy was largely attributed to the blockage in the banking sector which Tarp targeted.

    Wade said the stumbling block for the plan now was the price the authorities were prepared to pay for the assets, primarily unwanted and illiquid mortgage-backed securities.

    “Too low a price and the banking sector goes bust, too high and it is a simple bailout for the banks — bringing with it charges of socialism for the rich and reward for bad lending decisions,” Wade said.