The Federal government is spending hundreds of billions of dollars to add liquidity to the financial markets to avoid a complete collapse. Here's a chronology of the how the crisis evolved, what caused it and steps the government has been taking along the way.
November. Citigroup Bailout Critical for Economy to Recover
The U.S. Treasury gave Citigroup a $20 billion cash infusion in return for $27 billion of preferred shares yielding 8% annual return, and warrants to buy no more than 5% of Citi's common shares at $10 per share.
Citigroup Bailout Critical for Economy to Recover
Tuesday November 25, 2008
Many people are wondering why Citigroup should get a bailout, and the Big 3 automakers were told to go packing. After all, both companies made bad strategic decisions - Citigroup in using too much leverage in buying mortgage-backed securities, and the Big 3 in not retooling for more fuel-efficient vehicles. Both have thousands of employees that will be laid off if the companies go bankrupt. Are banks somehow more important to the economy than auto manufacturers?
Perhaps not morally, but financially they are. To get this economy back on its feet, it needs capital more than cars. Banks provide that. However, with last week's 800 point drop in the Dow, banks assets are too low to give them money to lend. That's why the Citigroup bailout included options to buy common stock, which shows government support of common stockholders. This caused the Dow to regain last week's loss in two days. This rally for financial stocks means more capital for banks, and more capital for them to lend.
The U.S. Treasury gave Citigroup a $20 billion cash infusion in return for $27 billion of preferred shares yielding 8% annual return, and warrants to buy no more than 5% of Citi's common shares at $10 per share. More importantly, the Treasury will guarantee $306 billion worth of toxic mortgage-backed securities, helping Citi to get these off of its balance sheet. In return, the bank will absorb the first $29 billion in these losses before the government guarantee kicks in. Citi also received $25 billion last month under TARP. (Source: Barron's, A Tale of Two Cities, November 25, 2008)
Obama's $500 Billion Bailout Plan
Wednesday November 26, 2008
President-elect Barack Obama announced a Economic Stimulus Plan that could run between $500-$700 billion over the next two years. The plan includes creation or retention of 2.5 million jobs through a $25 billion public works construction program, a $3,000 tax credit to businesses for each new hire, and $50 billion to auto companies for retooling to produce energy efficient vehicles.
What It Means to You
Many people are worried that the billions of dollars being pumped into the economy by government stimulus plans will lead to hyperinflation. That is not a concern right now, since deflation is a greater risk. The credit crisis was caused by over-leverage, and the winding down of that leverage has caused a 27% decline in housing prices and more than 40% decline in the stock market. These are not captured in the government's inflation report. Once the economy is back on its feet, Obama and the Fed can enact measures to stem inflation.
Fed's $800B Plan Lowers Mortgage Rates
Thursday November 27, 2008
The Federal Reserve will spend $800 billion to purchase mortgage-backed securities from Fannie Mae and Freddie Mac, as well as consumer loans. The Fed will purchase $100 billion in consumer loans next week, and $600 billion in mortgage-backed securities by year end. As a result, rates for a 30-year fixed mortgages fell to 5.5% from 6.38% Wednesday morning. (Source: Barron's, The Fed Tries to top TARP, November 26, 2008)
What It Means to You
The Fed was successful in spurring commercial bank lending with the Commercial Paper Facility several weeks ago, although activity has stabilized. Mortgage applications should start to rise, as well, since Fannie and Freddie will have unloaded some of their debt and will be free to make new loans. However, the questions remains as to how much demand is there for mortgages.
However, if you are facing an interest rate reset and higher monthly payments, now would be a good time to refinance to a fixed-rate loans. Even though LIBOR rates have come down from earlier summer highs, there is still a lot of volatility in financial markets, and it is better to be safe than sorry.
Economy Slowed in Q3 Slightly More Than Original Estimate
Sunday November 30, 2008
Q1 GDP Growth
The BEA preliminary report for the U.S. GDP growth rate for Q3 2008 was a negative.5%, down slightly from the advance report estimate of .3% decline. However, it represents a substantial decline from the 2.8% growth in the second quarter. The decrease was due to the first decline in consumer spending since 1991 and the biggest drop since 1980. The slowdown in growth would have been worse without increased government spending. (Source: GDP News Release)
What It Means to You
This is the second quarter of negative GDP growth in a year, thereby confirming for me that we are in a recession. The definition of a recession is when GDP growth is negative for two or more consecutive quarters. However, the 2001 recession was pretty bad, and did not see any consecutive quarters.
Furthermore, most economists are predicting that the next quarter will be negative, so I am just calling the official recession one quarter early. The last negative quarter was Q4 2007, which was down .2%.
Growth for 2007 was 2%, down from the 2006 growth rate of 2.8%. This decline in growth has been due to the housing market slowdown and related weak consumer spending. For a review of the most recent GDP reports, see GDP Current Statistics
Durable Goods Orders Down 10% From Last Year
Tuesday December 2, 2008
The October Durable Goods Orders Report shows that manufacturers are struggling due to the slow economy. The Census Bureau reported that business orders for machinery, computer equipment, and the like decreased 9.9% in October when compared year-over-year. (Source: Census Bureau, Report on Manufacturer's Orders, Advance Report, Table 1, seasonally adjusted figures)
Why are durable goods orders so important? Since they represent the orders for big ticket items, businesses will hold off making the purchases until they are confident in the economy. Therefore, decreasing orders mean decreasing production, which has led to a slowdown in GDP growth. That's why the Durable Goods Order report is generally considered one of the more important leading economic indicators.
By the way, most articles you read compare this month to last month, which showed a 6.2% decline since September. However, year-over-year comparisons do a better job of predicting the GDP report, which is also year-over-year. (See Durable Goods Spreadsheet in Google docs)
What This Means for You
The current credit crisis has slowed foreign economies, which has slowed orders for U.S. exports. This has contributed to our current recession . Continue to watch the important economic indicators to see how long the economy will remain in this slump.
Volcker Best Pick for Obama Economic Advisory Board
Wednesday December 3, 2008
Former Federal Reserve Chairman Paul Volcker (1979-1987) was recently appointed by President-elect Barack Obama to head his Economic Recovery Advisory Board. Volcker's aggressive action against double-digit inflation in the late 1970's has reassured the markets that he will take an equally tough stance to combat the current recession. Volcker has blamed poor financial regulation for the current crisis, and will probably advocate tougher restrictions. He will play a key role in shaping the new board with independent-minded leaders from business and academia.
What It Means to You
As Federal Reserve Chairman, Volcker raised the Fed Funds rate to 20% and kept it high until he saw that inflation was in check. Thanks to Volcker, economists and central bankers now realize that managing inflation expectations is the most important way to manage inflation. The same is true for deflation. Volcker will advocate aggressive action to restore business and consumer confidence, which will help in shortening the recession. (Source: Bloomberg, VVolcker to Lead New White House Panel, November 26, 2008)