Will the bailout succeed?

Will the bailout succeed? 

Investors need to be convinced that it is safe to put money in financial firms 
  
Will the bailout relieve US of the threats of unemployment, badly structured mortgage loans and a banking system in upheaval? Analysts believe it could be years before consumers feel flush again, especially if credit conditions remain tight. — PHOTOS: ASSOCIATED PRESS, AGENCE FRANCE-PRESSE, REUTERS
 
WASHINGTON: The best test of whether the United States government’s US$700 billion (S$1 trillion) cheque will be enough to save the US economy is how much of that money flows back to consumers and companies.

Even if the government gets congressional approval this week to buy bad debts off banks’ books, satisfying some of their cash needs, the financial sector will still need to raise money - and investors have not exactly been lining up to help.

Unless banks can find funding somewhere, they will not be eager to resume lending, and that will leave the economy sputtering.

The good news is, outside of the financial sector, Corporate America is remarkably cash-rich with some US$620 billion sitting on the books of large firms, so companies should be primed to spend once confidence is restored.

But household wealth has taken an unprecedented double hit from the real estate and stock market shocks. It could be years before consumers feel flush again - particularly if credit conditions remain tight.

US Treasury Secretary Henry Paulson argued on Sunday that opening up federal coffers to Wall Street would benefit Main Street by preventing a deeper economic downturn.

‘Last week as the credit markets were frozen, the capital markets were frozen, we had a situation where American companies were not able to borrow money,’ Mr Paulson said on ABC’s This Week. ‘This could ultimately affect small banks, loans to businesses, loans to farmers, jobs, people’s retirement.’

US companies have cut more than 550,000 jobs this year, sending the unemployment rate up to a five-year high of 6.1 per cent last month. Those figures are likely to worsen in the coming months, with or without a bailout.

The housing market is at the root of the year-long financial crisis, and some members of Congress - expressing concern that Mr Paulson was taking a roundabout route to helping homeowners - are expected to push for more direct mortgage assistance when they hammer out terms of the bailout legislation this week.

‘I have talked to Secretary Paulson, and I have told him that while his plan is a foundation and we certainly have to do something, we need changes in it relating to housing,’ New York Senator Charles Schumer said on Fox News.

Lawmakers will get the latest readings on the housing market this week as they hash out the Paulson proposal. Sales of both new and existing homes likely fell last month and the pace of transactions remains near the slowest in more than a decade.

Shoring up the housing market means ensuring that would-be buyers can get mortgages, and that means banks will have to find a way to keep lending. Credit conditions were tightening, even for borrowers with good credit histories.

‘The US banking system needs a lot more capital,’ said Mr Jan Hatzius, chief US economist at Goldman Sachs. ‘Capital infusions are needed to avert a sharp contraction in lending.’

He said three things need to happen in order to resolve the crisis. First, banks must figure out the true value of assets on their balance sheets; then they must raise more capital; and finally, home loans needed to be restructured.

The government’s bailout plan in effect addresses the first point by establishing a price for hard-to-value assets, and Congress may tackle the third issue this week. However, raising more capital will not be easy.

Lehman Brothers failed last week because it could not find investors. Getting US$700 billion in bad debts off banks’ books will certainly help, but it remains to be seen whether that will be enough to convince investors it is safe to put their money in financial firms.

If the government’s money succeeds in helping Wall Street strike a healthy balance between fear and greed, US companies are well-positioned to fund a strong recovery once they are confident that the economy is on the mend.

The Standard and Poor’s (S&P) industrials, a group of 368 large companies that excludes banks, insurers, utilities and transportation firms, held about US$620 billion in cash and short-term securities as at June 30, according to S&P analyst Howard Silverblatt.

That was roughly the same amount they had in March last year, before the financial market crisis mushroomed. Since then, companies have cut back on dividend increases, share repurchases and expansion, essentially hoarding cash because of concern about the state of the economy.

‘They have got money,’ Mr Silverblatt said. ‘They are not spending it yet.’

REUTERS

 
Source : Straits Times  - 23 Sept 2008

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