The President’s Financial System Overhaul: It’s Time

Morris Segall      2009 economy, bailout, banking system, business landscape, economy, The new Fed actions

After a year of speculation and discussion, President Obama released his plan for reform and regulation of the nation’s financial system. There were few surprises. With more oversight and control centered in the Federal Reserve and augmented with newly created boards, the plan brings under new regulation and supervision virtually all major sectors and products of the financial services industry.

Born out of the cataclysmic financial losses of the current recession, the President’s plan seeks to avoid a repetition of the circumstances and events that led to the recent financial system meltdown. It is the quid pro quo for the federal government bailing out the U.S. credit system and nobody should be surprised at the far reaching reform and regulation embodied in the plan.

In the most sweeping regulation of the financial sector in this country since the Great Depression, it creates unprecedented power to seize banking institutions and intercede in the transaction systems in the financial marketplace. This would include the “breakup” of large financial conglomerates that pose a heightened risk to the functioning and integrity of the financial system.

Critics are bemoaning that the increased intrusion of the federal government in the affairs of the financial marketplace may cause restriction and higher costs of credit to borrowers. With all due respect, that has already occurred as a result of the massive debt losses sustained by the nation’s credit intermediaries and its investors and placement firms.

Like it or not the financial marketplace and its players are going to have to deal with more stringent governmental oversight and regulation to protect the country from another financial meltdown from insufficient credit risk underwriting.  The constriction of credit, the inability to conduct market transactions in asset backed securities and consumer and banking failures necessitate the comprehensive overhaul of the nation’s financial system.

The mandating of increased oversight of the nation’s banks including higher capital and liquidity standards and the assumption of prudent risk and the offering of high risk products will force the banking system to adopt a more stable lending and responsible posture. The regulation of credit card companies and mortgage brokers and other financial intermediaries serving consumers is required to also enforce higher standards of professional conduct, better risk underwriting and most of all, consumer protections from fraudulent and abusive practices.

Importantly, the overhaul plan includes regulation of the “paper” created around the asset based lending that leveraged and securitized these transactions and have been a major contributor to investor and lender losses as the value of such paper eroded more than the assets they backed and became illiquid.

Unfortunately, the President’s plan does not use this opportunity to streamline the regulatory system. We believe there are still too many agencies involved in the new regulatory framework and may lead to inefficiencies and inconsistencies in industry oversight. However, no new regulatory plan of this magnitude was going to be perfect and the overall benefits will outweigh the organizational faults. We also believe industry participants will adapt and operate successfully in the new environment and/or exit the more risky sectors of the financial marketplace. This will inure to the benefit of lenders and borrowers in providing a safer and fairer financial system.

The credit industry over the 2004-2007 period lost its way and its mistakes in the extension of credit to poor credit risks and the leveraging of those risks would have plunged us into a massive depression were it not for the Herculean federal rescue. It’s time we got this critical industry and system back under control.

Morris R. Segall, CFA, CIC

In the Global Fight Against Recession, Is the U.S. a Party of One?

Morris Segall      bailout, banking system, economy, government, The new Fed actions, their implications and political fallout, treasury

Today the Federal Open Market Committee voted to increase the stimulus to the credit markets by keeping the Fed Funds rate in a 0%-.25% target range. In addition they voted to have the Fed purchase:

• Up to $300 billion of long-term Treasury securities
• Another $100 billion of U.S. Government Agency debt making a total of $200 billion
• An additional $750 billion of mortgage backed securities making a total of $1.25 trillion

In addition the Open Market Committee voted to launch the Treasury’s TALF program to purchase consumer and business asset backed securities. This program will start at $200 billion but could expand to a $1 trillion.

The Fed’s actions are based on what the Open Market Committee states are continued recessionary pressures in the U.S. economy. With today’s actions, the balance sheet of the Federal Reserve is estimated to have expanded to approximately $3 trillion. This compares to assets of less than $1 trillion six months ago. It would seem the Fed is throwing in the towel on a recession bottom in 2009.

This compares to Chairman Ben Bernanke’s testimony on February 14th before the U.S. Senate Banking Committee in which he forecast an end to the recession by the end of this year. Clearly there is some disconnect between the Fed’s current actions and the Federal Reserve Chairman’s outlook.

Indeed, the most recent economic data released this month and recent corporate announcements from several large banks indicate there is some hope the pace of economic and earnings contraction may be slowing. We have communicated to our clients and audiences that we felt the worst of the current recession would be felt in the first quarter of this year. If we and Chairman Bernanke are correct, today’s Fed actions are too much at the wrong time and will have negative consequences intermediate-longer term. We warned in our last blog posting, “Is There a Plan Here?” the increasing concern among international creditors about the future creditworthiness of the U.S. government given the outsized spending of the current bailout programs. It is noteworthy that the Chinese government just last week expressed misgivings about their large holdings of U.S. Treasury debt and further purchases going forward. Today’s massive new spending by the Fed will cause further alarm in international financial circles. While today’s announcement of Fed purchases of long term Treasuries suppressed interest rates on government debt and provided fresh fodder for further stock market gains, it is important to note today’s large decline in the value of the U.S. Dollar in currency future markets and the simultaneous large increase in the price of gold futures in commodity markets.

The Federal Open Market Committee is preoccupied with deflation as a result of the current recession. Yet the price of oil has moved to nearly $50 per barrel from approximately $35 per barrel a month ago. In addition the most recent reports on consumer prices for January and February show an annualized rate of inflation of 2.5% excluding food and fuel and inflation and rates much higher in key non discretionary spending categories. The recent rise in energy and service prices belie a chronic deflationary environment or outlook. The unbridled U.S. government and Federal Reserve spending on the multitude of stimulus and bailout programs has been rejected by our overseas trading and financial partners despite this government’s pleas for more foreign government stimulus spending. These governments are afraid of the inflationary bubbles and sovereign balance sheet erosions that will result from such unfettered spending. So the Treasury Dept. and the Fed plot their own course of uncapped spending as their answer to the current credit and economic dilemmas.

Speaking of dilemmas, President Obama is feeling the heat on what is clearly a botched bailout of AIG and an erosion of confidence amongst economists and politicians in Treasury Secretary Geithner. The public is angry and very stressed over the recession. The economy is President’s Obama’s and the Democratic Party’s problem now and the public wants to see results from the hodgepodge programs the government is implementing. The current scandals regarding executive bonuses and the perceived inadequacies of the Treasury leadership will in our opinion start to erode the President’s poll numbers adding a further difficulty to the current social and economic environment.

Morris R. Segall, CFA, CIC

The Real Cost Of The Bailout

Morris Segall      bailout, banking system, obama

I’ve said publicly in the past that that I thought the cost of rescuing the banking system and the economy would easily be $2 trillion. It now looks like the Obama administration has a $700 billion stimulus package in the works on top of the current bailout package and the cost of bailing out banks and Wall St. so far.

If the $700 billion price tag of the Obama program is true, we are there.

This will likely not be the end and we could be looking at more than $2 trillion before this is all over. The impact on the Federal budget deficits and national debt will be enormous.

It also appears a major public works/infrastructure program will be part of the stimulus program. I have also been quoted by the Philadelphia Inquirer that I did not believe such a program will have the desired effect the government assumes. In an economy where more unemployed are white collar workers and state and local governments are slashing transportation and infrastructure programs, it is dubious the federal public works spending will have the multiplier stimulus impact.

We really need to have a whole new approach to this economy that is nothing like the historic post-war economy we have grown up with. Look what is happening to auto dealerships as a result of the demise of the big 3 auto makers. Historic solutions to recessions have already not worked, i.e. lowering interest rates alone. Bailing out sick companies is not the answer. Uncapped public spending to bail out companies will cost us dearly down the road.

The government’s strategy must be to put consumers back on their feet.  If the government wants to help consumers get back on their feet, they need to find jobs publicly or in the private sector for all of the white collar workers from finance, trade, business services, etc. that are chronically unemployed and are not finding ready re-employment.