February-March 2009

On 13 February, President Obama's $787 billion stimulus plan was finally approved. A mixture of tax cuts and spending initiatives, the plan seeks to create up to four million domestic jobs and eventually revive the country's economic fortunes, although opinions differ considerably as to how long it might take before the plan's ambitions become reality.

While the plan is designed to jump-start the overall economy, the degree of its impact will be influenced by a separate $700 billion financial-rescue package that is intended to breathe new life into the nation’s moribund credit markets. Now known as the Financial Stability Plan (FSP), this package, in its original form, was the TARP (Troubled Asset Relief Program), although the new version goes well beyond the scope of its predecessor.

The FSP takes a three-pronged approach to stabilising the financial system, and will provide additional capital for banks where necessary, financing for consumer and business loans, and financing for private investors willing to acquire “distressed assets”. The hope is that, once their balance sheets have been cleaned (of “toxic” debt), and provided capital adequacy is assured, the banks will resume lending. Other measures in the package include stricter risk disclosure requirements and accountability provisions.

The ready availability of credit is a major prerequisite for economic recovery. So, as the FSP is primarily concerned with restoring the ability of consumers and businesses to raise finance for spending and investment, its success or failure will likely determine the effectiveness of the general economic stimulus plan. Investors are disappointed with the FSP, largely due to a lack of detail as to how it might be implemented.

Nevertheless, much will depend on the response of the banks to the FSP. Government intervention has meant that US banks have been partially nationalised, a notion that smacks of socialism and contradicts US freemarket, capitalist thinking. However, while state ownership is something of an ideological anathema for Americans, a government-backed bailout is apparently acceptable, if only as a last resort. Nor is it anything new: the first US bank bailout occurred in 1792.

The most recent instance of a bailout in the US financial sector was the rescue of the country’s Savings and Loans (S&L – mortgage lenders, akin to building societies in the UK) industry in the 1980s and 1990s, with which there are certain parallels with the circumstances now prevailing: several S&L failed after lending excessively in the mortgage market; also, the establishment of the Resolution Trust Corporation (RTC), a so-called “bad bank” into which the defunct S&L and their assets were absorbed and later sold, is an idea that has received serious consideration lately.

The RTC cost around $300 billion in today’s money, but managed to recoup about 80% of what it had paid for the distressed assets. For policymakers addressing the current situation, however, the RTC’s success is of scant comfort. Whereas the S&L debacle was confined to only one area of the US lending market, the ongoing crisis has infected the entire global financial sector, and will therefore require more comprehensive measures to resolve. Despite investors’ initially sceptical reaction to the FSP, in the absence of an alternative plan, they must hope that it is a step in the right direction.