November Market
The central question in the context of credit crisis of the November market is why do the creditors suddenly refuse to invest more money and its bail out plans. Actually, far from being an isolated fact, it is a part of a complex chain reaction. The lenders reel under deficit money supply when they fail to realize the interest or even the actual capital they had invested on companies or institutions, which accrued a disastrous amount of losses. Such loss incurring companies cannot return the money they had borrowed from the creditors and have to default payment. In the case of such defaults, the banks try to mortgage or sell the properties of defaulters.
However, when the prices begin to fall, even the bank has to sell out at considerably lower prices and suffer huge losses. Consequently, their ability to lend money is severely crippled. In certain cases, the banks are required to raise the level of capital reserves and to comply with this have to restrict lending. Even when banks perceive a risky market, interest rates may shoot up to discourage lending leading to credit crunch. (Labaton, 1).
Five of the leading banks of the world, including the Federal Reserve Bank of USA came together to invest huge amounts of fresh money into the global market to combat international credit crunch failing economy. This move was largely stimulated by the concern of leading economists who were predicting a recession in US markets as a slowing down or decline of US and British housing markets. In an emergency set of solution seeking procedures, the Federal Reserve Bank drastically diminished interest rates, splurged out innovative lending programs, sought to modify the poor condition of Bear Stearns and provide loans to boost the nearly crippled mortgage agencies of Fannie Mae and Freddie Mac. It was, however, not as if, the Federal Reserve Bank was taking over every financial proposition in US, but had to do so because it was big enough to stem crisis.
It should be remembered that under these conditions, “Blackstone closed a record $21 billion fund just as the credit crunch began in August 2007, and has reportedly raised the first $9 billion of a new fund already this year. Though debt is scarce for most deals, meaning Blackstone must risk more of its equity, it has been preparing for a downturn, for example by buying a hedge fund with expertise in stressed debt.” (Schwarzman, 1).
Huge amount of capital inflow is needed in this case and even if the bailout plan succeeds it is evident that there would be difficult times. However, in the event of magnifying unemployment and inflation, the Federal Bank cannot afford to sit still. It has to fight for a stable equilibrium in prices and combat unemployment. The most innovative plan to diminish the credit crunch has been to increase lending with the motivation tom restore liquidity to troubled markets and look after the demands of the inter-bank loaning facilities. The current crisis made the Federal Bank to decrease the interest rates on lent amounts and lengthen the time limit for the repayment of the loan. “Term Auction Facility” was adapted as a scheme for slow banks through which loans at a cheaper rate could be made available from discounts windows and the deals were guaranteed anonymity.
Rescue plans
As a bailout plan, the article “In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans” by Stephen Labaton and Edmund L. Andrews published in New York times on September 7, 2008 can be very useful for its logical reasoning. This article is a take on the recent credit crunch of US. Huge amount of capital inflow is needed in this case and even if the bailout plan succeeds, it is evident that there would be difficult times. However, in the event of magnifying unemployment and inflation, the Federal Bank cannot afford to sit still. It has to fight for a stable equilibrium in prices and combat unemployment. The most innovative plan to diminish the credit crunch has been to increase lending with the motivation tom restore liquidity to troubled markets and look after the demands of the inter-bank loaning facilities.
The current crisis made the Federal Bank to decrease the interest rates on lent amounts and lengthen the time limit for the repayment of the loan. “Term Auction Facility” was adapted as a scheme for slow banks through which loans at a cheaper rate could be made available from discounts windows and the deals were guaranteed anonymity. (Labaton, 1) Under such parameters the fundamental bailout plan “Hank Paulson’s $700 million no-strings-attached proposal” was disapproved by the US House of Representative. (Rankin, 1) However, even in this situation there is a hint of positive aspect. “The economic cycle has clearly shifted into a dramatic downturn, and so a different planning approach is called for. But by knowing where you can take advantage of the situation, it is possible to make the downturn much less painful financially, and in some cases, it may even be possible to take advantage of it.” (Ludwig, 1).
There is however, a second bailout plan. It is referred to as Plan B. The Republican Senate endorses this plan after the failure of the Plan A. It has been reported, “tax credits for the production and use of renewable energy sources, like solar energy and wind power have been. Possible other inclusions originating in the House bill are an extension of the unemployment benefits, protection from foreclosure for individuals, and tax credits for low and medium income households.” (Rankin, 1) Under such parameters, it can be stated that the this plan was initially supposed to be workable but a Plan C was initiated to be effected as a proper bailout method.
Plan C includes an additional input of US$800 billion by the Bush Government during its outgoing days. The amount of US$800 billion would be instrumental in buying the debts related to mortgage and the credits of the consumers in order to instrument a lending free up. At this point of time it appears that there are two major problems related to this Plan C. The first one is the fact that there is not enough retail economy spending in relation to consumers. Secondly, there is a lack of consumer credit and there is no presence of a sound economy to sustain this amount. It is reported that “the Federal Reserve and US Treasury are pumping a jaw-dropping $800 billion directly into the credit markets, buying up $600 billion worth of mortgage debts”. (3 news, 1) The net probable result is that “agencies like Freddie Mac and Fannie Mae can keep mortgage credit flowing, and setting up a new $200 billion loan fund to buy up consumer credit and prop up the market for auto loans, student loans and credit cards.” (3 news, 1).
Opinion and the difference between 2nd and 3rd plan
According to Heitfield, “To a large degree, the potential for dramatic falls in ratings and valuations was “baked in” to the securitization process” where “Credit rating and valuation models depended on limited data – could not accurately assess the likelihood of future losses” (Heitfield, 1) Thus, these situations should be taken into account for future prospects. Although banks have been the most popular method of economic growth, they are quickly becoming one of the least reliable sources. Private enterprise is taking a new face in the modern world and is helping to facilitate strong economic growth, even during a time of recession. In this modern day and age, businesses are becoming more personal, which most people enjoy. This gives people a larger sense of trust with companies and allows them to get more loans. When people have more money, the spend more and put more back into the economy. It is plain to see why market based financial systems are the superior method of economic growth. Whenever you de-regulate how business is run, people tend to show the good side of them more and help each other out more. Laissez faire is an important cornerstone in today’s free world market, and it should stay that way. Banks are still regulated by the government, and obviously have been failing to keep up to par. The choice is obvious and hopefully, the government begins to support private financial groups more in the future.
Under such parameters, if the plan B is taken into consideration, it can be stated that this plan appears to be a very slow process. This could be a very dangerous ploy and the result could be devastating for the economy. It should be noted that a very fast and effective measure is needed and Plan B lacks that speed of operations that is required in this case. As per implecation of Plan B is concerned it can be mentioned, “Pressure is also mounting from constituents for Congress to take action to stop the extreme volatility in the markets as their investments have plummeted. While stiff opposition to a bailout of Wall Street is apparent, direct damage to the net worth of individuals has prompted a call for action” (Rankin, 1) Thus, it appears that Plan B is not workable at all.
On the other hand, Plan C has its own faults. Henry Paulson, Treasury secretary, indicates, “This lack of affordable consumer credit undermines consumer spending and as a result weakens our economy“. (3news, 1) Thus, it is difficult to implement this plan on a large scale. The market appears frozen and the credit system is crippled as investors pulled out $240 billion out of the market particularly from the field of auto loans and credit card market. The Federal Reserve bailout plan of $180 billion could be instrumental in luring investors into the market. In a way, this could prove to be the ideal stage to implement Plan C though there are enough risk involved. Nevertheless, Plan C is quite complicated in nature and it the Federal Reserve is reluctant to use it right now and hold it until February 2009. (3 news, 1).
However, serious situation demands serious risks. As it is, it looks like the Plan B would not be effectively instrumental without a long termed result and this is a situation that needs quick response. Thus, the best measure is to wait until February 2009 and implement the Plan C. During this time the drawbacks of the plan would be well sorted out and thus the implementation would be more error free and sustainable. That way, it would be faster and effective than Plan B. Thus, Plan C is the most favorable plan under these circumstances and the government should be instrumental in implementing this plan.
Works Cited
Labaton, Stephen & Andrews, Edmund L; In Rescue to Stabilize Lending, U.S. Takes Over Mortgage Finance Titans; NY Times; 2008. Web.
Schwarzman, Steve; Raging bull; The Economist; 2008. Web.
Heitfield, Erik; Resecuritization: a Post Mortem; National Association of Business Economics Annual Meeting; Federal Reserve Board; 2008.
Ludwig, Ronnie; A silver lining for the credit crunch?; BBC NEWS; 2008. Web.
Rankin, Kyle; Plan B: Go to Congress, Make a Right; Black and White Program; 2008. Web.
US to try bailout ‘plan C’ to solve credit crisis; 3 News / CBS; Wed, 2008. Web.