Just about everyone with a television, access to the internet, or a newspaper probably knows, the economy is floundering. While this is based on multiple factors such as sub-prime mortgages, bad investment advice, the housing market, etc. (this list is long and distinguished,) there may be light at the end of the tunnel. At the minimum, there may be a method to the madness regarding the injection of money into the economy by the Federal Government.
The "bailout," formally known as the Troubled Asset Relief Program (TARP) has many confounded and wondering if dumping money into financial institutions is all for not at the tax payers expense. While many are angry over this, I am starting to piece together what I hope is happening with this program and the other funds being funneled into the economy. And I'm very excited about it.
Let's walk through it. The Government approved a 700 billion dollar bill to cover the potential loss to financial institutions throughout the country. They immediately made 350 billion available to those institutions, thus providing liquidity (liquidity is money in financialese) to the banks to lend. So in essence, they put a base under the problem. They soon realized that this wasn't enough to get the economy moving in the direction that they wanted it to go. By this point, the damage was done in regards to consumer confidence. You may remember that immediately after they approved the bill, the stock markets' decline escalated rapidly. This decline along with the significant downtrend in real estate had everyone tightening up on every level.
Shortly thereafter, the Federal Reserve Bank realized that simply lowering the Prime Rate (which controls car loans, commercial loans, credit cards, home equity lines, etc.) was not having an impact. In an attempt to push their agenda further in the right direction they announced that they would be putting an additional 600 billion into Asset Backed Securities. These securities include credit cards, student loans, and more importantly, Mortgage Backed Securities. This is where it gets good. When this happened the 30 year rate dropped from around 6.5% to 5.5% for residential mortgages. Thus creating a very large jump in mortgage applications.
Since this announcement, there have been other suggestions floating around about how they will continue this initiative, and perhaps guarantee it for a reasonable period of time. One suggested approach, which I believe will come to fruition in some capacity, is that the Government will guarantee the mortgage rates at 4.5%, though only for the purchase of owner occupied homes. They can accomplish this through various subsidies and tax credits to the lenders. And by forcing the rates down through mortgage backed securities, they are reducing the spread that they will have to pay on a case by case basis to get to 4.5%. Ultimately, lowering their cost for reducing the rate.
While I am not an economist, I do have a simple theory on this. Let's tie it all together. The TARP provided necessary capital to the lending institutions. Now the banks have the money to lend. They followed that action by lowering the short and long term interest rates, which enticed people to borrow money against their home and business. Eventually, they will push rates down even further with incentives for people to buy homes. Ideally, this will only be offered for a limited time so that homebuyers will feel a sense of urgency to buy. In doing so, they will actually jump start this economy from the root of the problem, which is housing. In short, people's houses will sell, people will buy new houses, builders will build new houses and create jobs, people will refinance and save money or they will pull cash out of their homes to pay off debt. All of this will contribute to a stable economy. It will actually get us moving in the right direction. From that point, the stock market will find a bottom due to consumer confidence being restored.
And the best part about it is that the Government is actually investing in itself through Fannie Mae and Freddie Mac. So "we," the American taxpayer, could actually make money on this deal. Go figure.
And hopefully, after all of this we will have learned something.
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