Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Slam, pan, bemoan, disappoint. Praise was nowhere to be found in the headlines reporting reactions to the much-anticipated bank bail-out plan Treasury Secretary Timothy Geithner announced two weeks ago. 

Geithner had barely finished the press conference describing his “financial stability plan” before the criticism descended, beginning with an immediate 382-point decline in the stock market, followed by an instant consensus among commentators and lawmakers that the plan was too vague, lacking the details and clear government commitments required to bolster  the confidence of financial markets and consumers.  More “a tease” than a plain, is how banking industry analyst Bert Ely described Geithner’s announcement. “What was announced today was mere platitudes,” Sen. Bob corker (R-TN) agreed.  “It would have been better for the country had they waited until they had some clarity.” 

The plan Geithner outlined has three related components:

  1. A “fund for troubled banks” that would purchase underwater “toxic” assets from banks.  A variation on the “bad bank” idea that had been discussed previously, the fund would be financed through a public-private partnership, with the federal government providing seed money and, possibly, some limited guarantees against future losses, to encourage participation by private investors.
  2. A “fund for troubled banks” that would purchase underwater “toxic” assets from banks.  A variation on the “bad bank” idea that had been discussed previously, the fund would be financed through a public-private partnership, with the federal government providing seed money and, possibly, some limited guarantees against future losses, to encourage participation by private investors.
  3. Expansion of the Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF), increasing from $200 billion to as much as $1 trillion its capacity to purchase securities backed by automobile, credit card and student loans.  The expanded program would add commercial mortgage-backed securities (but not residential mortgages) to TALF’s authorized purchase list.
  4. More government aid for banks deemed most in need of financial assistance but with strings attached to future capital infusions, including: A cap on executive compensation; a ban on using government funds to pay dividend to shareholders or purchase healthy institutions until the government investment has been repaid; and requirements that aid recipients disclose how they use the funds they receive. Banks receiving assistance will also be subjected to a Treasury “stress test” to assess their financial condition and to help regulators establish uniform values for the underwater assets on their books.

Critics, who generally approved the plan’s broad thrust, complained that it failed to answer critical questions: 

  • How the public-private investment fund charged with purchasing toxic assets will operate and specifically, what will encourage  investors, who have been reluctant to purchase these assets, to do so now, especially since it appears that the Obama Administration has decided not to offer financial guarantees that would set a floor under declining values.
  • How the public-private investment fund charged with purchasing toxic assets will operate and specifically, what will encourage  investors, who have been reluctant to purchase these assets, to do so now, especially since it appears that the Obama Administration has decided not to offer financial guarantees that would set a floor under declining values.  How this plan will accomplish what its predecessor, crafted by former Treasury Secretary Henry Paulson, failed to achieve:  An increase in bank lending to businesses and consumers.
  • How the government will treat financial institutions that fail the new stress test -- by pumping more capital into them or closing their doors.  “”He [Geithner] says we need to stress test banks, but they’re already in the middle of the biggest stress test in decades,” Brian Bethune, chief U.S. financial economist for Global Insight, told the Washington Post. “The question is:  Are they able to survive the current cycle, and if they need government help, what will the conditions be?”
  • What the Administration will do to address the still rising tide of foreclosures.  (President Obama is expected to announce a separate plan dealing with that problem this week.)

While critics pointed to the stock market plunge as evidence that the plan was not all it needed to be, Administration officials rejected that analysis. Investor reaction is “the wrong measure,” Lawrence Summers, director of the National Economic Council, told reporters. “The President has made it clear that the focus of our economic policies is on financial and economic performance over time, not day-to-day fluctuations in the markets.”

Geithner also defended the plan and its lack of detail, emphasizing the need for Treasury “to do this in a way that is careful and responsible.  I completely understand the desire for details and commitments,” he said in testimony before the Senate Banking Committee.  “But we’re going to do this carefully [to avoid] the quick departures and changes in strategy” for which former Secretary Paulson was roundly criticized.  “I do not want to compound the mistakes of the last 12 months, when things were rushed out before they were ready and strategy had to be adapted because of that,” Geithner continued.  “If that means there is going to be disappointment with the level of details until we get it right,” headed, “I will live with that disappointment, because it is better than the alternative.” 


The Obama Administration is expected this week to announce a critical missing piece of the financial rescue plan Treasury Secretary Tim Geithner announced recently (see related item):  A program to curb the tidal wave of foreclosures that is driving homeowners by the thousands from their homes, crushing the housing market and deepening the economic downturn in the process.   

Several major lenders have temporarily suspended foreclosure actions, pending announcement of the Administration’s plan.  Responding to a direct request from Rep. Barney Frank (D-MA) – which came during a public hearing at which bank executives were being lambasted for the mess they have made of the financial system, J.P. Morgan Chase, Morgan Stanley, and Bank of America all agreed to suspend foreclosures through March 6th.  Citigroup, which froze foreclosure actions in November, announced an extension of its moratorium until March 12th or the announcement of the Administration’s foreclosure mitigation program, whichever is earlier. 

Separately, the Office of Thrift Supervision (OTS) is urging the 800 savings and loan institutions it regulates to adopt a temporary foreclosure moratorium “until the [Administration’s] new plan takes hold.”  This voluntary action by lenders would “be supporting the national imperative to combat the economic crisis,” OTS Director John Reich said in a letter to lenders.   

Fannie Mae and Freddie Mac have announced that they are extending the foreclosure moratoriums they announced in November, that were supposed to last only until the end of last year.  Fannie Mae continues to delay foreclosures and is also suspending evictions from properties on which lenders have foreclosed.  Freddie Mac has adopted a narrower policy, suspending evictions only from occupied one-four-family properties, but not from multi-family dwellings with five units or more.   

These actions come as foreclosures increased by more than 80 percent last year, with more than 2.3 million homeowners facing foreclosure actions.  Completed foreclosures declined by 26 percent in January compared with the prior month, but analysts say the dip reflects the suspension of foreclosures by Fannie and Freddie, not any lessening of the foreclosure crisis.  

RealtyTrac reports that more than 274,000 U.S. households received at least one foreclosure-related notice last month and a separate study by a professor at Valparaiso University Law School found that lenders have delayed foreclosure actions on nearly 65,000 mortgages already past due by 180 days in November, simply because processing systems can’t cope with the volume.  Meanwhile, a new “mortgge ticker” developed by the Center for Responsible Lending is clocking 6,600 foreclosure actions initiated every week – one every 13 seconds.  At that rate, the CRL estimates, foreclosure filings will top 2.4 million this year. 

These statistics highlight both the extent of the problem and the limited success of varied public and private-sector efforts to deal with it.  For example, Home for Homeowners, enacted by Congress last year, was supposed to enable more than 400,000 homeowners to exchange their re-setting adjustable rate mortgages for more affordable fixed-rate loans.  But only 25 homeowners have qualified for that assistance to date. 


The financial and economic melt-down – now worldwide in scope – has made retirement a moving target for many American workers.  Would-be retirees in increasing numbers are postponing their planned exit from the workplace, calculating that they will have to work longer to offset losses in their pension funds and investment portfolios. 

Financial planners responding to a recent survey said that nearly 35 percent of their clients approaching retirement age are postponing their end-work dates, up from 32 percent last year, according to the American Institute of Certified Public Accountants, which conducted the study.  A majority of those delaying their retirement – 67 percent – plan to delay it no more than 5 years; only 9.6 percent plan delays of six years or more, the AICPA survey found. 

“What this suggests is that 70 is the new 65,” James Meltzer, a vice president of the trade group, said in a press statement.  “People, are living longer and getting more satisfaction from working later in life,” he added.  But it isn’t just a desire to remain professionally active that is keeping people at their desks, he acknowledged.  “The market downturn has reduced wealth and CPA financial planners are seeing clients delay their retirement plans as a result.” 

Planners said that 60 percent of their clients are postponing vacations because of the economic downturn and related financial setbacks; 52 percent are postponing car purchases and/or the purchase or sale of a home; and 42 percent have cancelled home renovation plans.  Only 11 percent of the survey respondents said they have clients with no plans to change their current spending.  


New secondary market standards for condominium loans are creating waves for lenders, who are being asked to scrutinize more closely the finances of community associations in which they finance condo purchases, and for the community managers who are being asked to provide the information lenders need to perform that due diligence.  The new rules require lenders to verify, among other details, that:

  • The community association is allocating a minimum of 10 percent of revenues annually for its reserves;
  • No more than 15 percent of the units are delinquent  by more than one month in the payment of common area expenses;
  • Owners have individual HO-6 insurance policies if the association’s master policy does not provide “all-in” coverage, that includes structural components and fixtures in  units as well as common areas; and  
  • Non-residential uses do not constitute more than 20 percent of the association’s revenues (or 20 percent of its space).

While many association managers are chafing at the time required to respond to increasingly detailed lender questionnaires (and at their potential liability if the information they provide is incorrect), industry analysts see a more troubling underlying concern:  Many community associations will not meet the new condominium loan standards and owners in those communities will find it difficult, as a result, to sell or refinance their homes.


The blistering critique that greeted the Obama Administration’s “financial stability plan” (see related item), may have reflected lingering frustration over the predecessor Troubled Asset Recovery Plan (TARP) crafted by former Treasury Secretary Henry Paulson as much as any fundamental objections to the “new” approach Paulson’s successor, Tim Geithner, is pursuing. 

Criticism of TARP I (as it has been dubbed) has been wide and deep, coming from Republicans, Democrats and, in hard-edged detail, from the most recent report issued by the Congressional Oversight Panel (COP) charged with evaluating the program.  Released a week before Geithner unveiled his plan, the report offered a scathing assessment of the capital assistance plan overseen by his predecessor, concluding that the program failed to price adequately for risk and so ended up paying “substantially more” for assets than they were worth – a far cry from the “par” transactions the former Treasury Secretary had promised. 

“Treasury simply did not do what it said it was doing,” Elizabeth Warren, the Harvard Law professor chairing the oversight panel, testified at a Congressional hearing.  “The American people want to know what’s going on,” she added, “and they deserve answers.”

The report analyzed the 10 largest TARP investments, concluding that the government paid $254 billion for preferred stock warrants worth only $176 billion – a $78 billion shortfall.  A separate report by the Government Accountability Office (GAO) found a smaller but still problematic $64 billion gap.  On average, the oversight panel said, Treasury received $66 in value for every $100 invested. 

The report faulted Treasury in particular for using a standardized formula for all TARP purchases – the equivalent, Warren explained in her Congressional testimony, of  buying 10 paintings, one Picasso, one Rembrandt, and eight by unknown artists, and paying the same amount for all of them.  “They didn’t price for risk,” Warren asserted. 

The oversight report elaborated on that point.  “The use of standardized documents likely contributed to Treasury’s ability to obtain wide participation, but it meant Treasury could not address differences in credit quality among various capital infusion recipients.”  That one-size-fits-all approach may have been designed to avoid the risk that differential terms would spotlight the weakest institutions, or that “failure of a weak bank would bring down stronger bank. “ Treasury may also have determined that providing subsidies to all institutions on the same terms was necessary “to preserve the integrity of the financial system,” report said.  But Treasury officials did not articulate that rationale and did not acknowledge that the asset purchases involved government subsidies, not the “par” transactions Paulson had proposed. 

The GAO report, also based on the Bush Administration’s management of TARP, found that Treasury had made “some progress” toward increasing transparency by requiring the 20 largest recipients of TARP funds to begin submitting reports detailing their use of the funds.  But the department has made only “limited progress” GAO said, in communicating its overall strategy for TARP (a reference to the shifting goals Paulson targeted as new problems emerged), and “has not yet developed a strategic approach to explain how its various programs work together to fulfill Treasury’s purposes or how it will use the remaining TARP funds….This lack of a clearly articulated vision has complicated Treasury’s ability to effectively communicate [the program’s benefits]  to Congress the financial markets, and the public,”  the report concluded.