Raw Finance

One of the reasons the Great Depression was so great (awful would be more appropriate) is that the federal government took a “hands-off” approach to the banking crisis of the early 1930s and allowed the markets to find their way through the morass.  I am strongly in favor of minimal government intervention in free markets – in good times this is the best way to promote growth.  However, an economic crisis such as the one we currently face require active government involvement in order to ensure the stability of the financial system because without a financial system there is no economy.  Thus, the government must do whatever it can, and print as many dollars as necessary to keep the credit markets from seizing up entirely or, worse, collapsing and disappearing.

Today, the Federal Reserve announced it was throwing another $800 billion at the problem:

• The Federal Reserve initiated a program to purchase  agency bonds as well as conforming mortgage-backed securities (MBS) backed by FannieMae, FreddieMac, and the Federal Home Loan Banks (FHLB) in the secondary market: “This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.” Purchases of up to $100 billion in GSE agency bonds will begin next week.  Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end.
• Under the new Term Asset-Backed Securities Loan Facility (TALF), the Fed will lend up to $200 billion on a non-recourse basis to holders of AAA-rated asset-backed securities (ABS) backed by “newly and recently originated” loans, such as for education, automobiles, credit cards and loans guaranteed by the Small Business Administration.
• The Federal Reserve Bank of New York (FRBNY) will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS.  The U.S. Treasury Department–under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008 (EESA)–will provide $20 billion of credit protection to the FRBNY in connection with the TALF.

Only $20 billion comes from the EESA, the rest is new money on the balance sheet of the Federal Reserve, which is why no new legislation was necessary.  This new program directly attacks, for the first time, the core issue of the economic crisis, falling housing prices.  By buying good (not toxic) mortgages and other consumer credit the government frees up money to be lent and this should result in lower mortgage rates.

So this is welcome news and, so long as the program is implemented quickly and consistently, it should help shore up key parts of the credit markets.  But my reader must understand that these efforts merely stablize the crisis, they do not magically return us to where we were.  The Dow Jones Industrial Average is not going to pop back up to 14,000 tomorrow.  This is not a criticism of the program, it will hopefully do exactly what it is meant to do – that is keep us from economic ruin, but it cannot stave off a very deep and long recession that has already begun.  As far as your investing is concerned, you may want to trade on a possible holiday rally, but tread carefully, and make sure that you continue to preserve capital because the recovery is still a long way off.