Fed Announces $800 Billion in Homeowner, Consumer and Small Business Aid

By Mike Caggeso
Associate Editor
Money Morning

The U.S. Federal Reserve and Treasury Department announced yesterday (Tuesday) $800 billion worth of stimulus measures to rev up three primary engines of the U.S. economy – homebuyers, consumers and small businesses.

This newest economic infusion follows a $700 billion banking system bailout package that was unveiled in late October. At least half the cash has been injected directly into U.S. banks and insurance companies, firing off a flurry of takeover deals – with more expected to come. And it precedes an anticipated package being designed by the new economic team that’s been assembled by President-elect Barack Obama. That package is still in its formative stages, but estimates of its ultimate size range from $500 million to $1.2 billion.

The $800 billion package unveiled by the Fed and Treasury Department yesterday consisted of several parts.

In one statement, the Fed announced it would purchase as much as $500 billion in mortgage-backed securities backed by the three government-chartered lenders: Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae. It will also buy another $100 billion in direct debt issued by those firms.

Beginning next week, the Fed’s primary lenders will auction off as much as to $100 billion of the housing-related debt. Selected asset managers will conduct purchases of as much as $500 billion of mortgage-backed security debt, hoping to have all those purchases completed by the end of the year.

“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,” the Fed wrote in a statement.

In a separate statement, the central bank announced the establishment of Term Asset-Backed Securities Loan Facility (TALF), a $200 billion program that will support asset-backed securities (ABS) – loans often taken for students, car owners, credit card holders and small businesses. One caveat: To be eligible, ABS exposure must be “newly or recently originated” by U.S.-based people and companies.

“Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity,” the Fed said in its second statement. “The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads.”

The Treasury Department will provide $20 billion of that from the $700 billion TARP initiative.

These packages are the latest in a series of aggressive rescue measures to unfreeze credit markets, but it also more than doubles the amount of debt the government is taking on.

“They’re trying to put funds into the system, trying to unfreeze these markets,” William Poole, the former St. Louis Fed president, said in an interview with Bloomberg Television. “Clearly, the Fed and the Treasury are beginning to take a large amount of credit risk.”

A Wider Target

Through TARP, the Fed’s initial efforts involved taking stakes in lenders – making investments of as much as $25 billion in such banks as Citigroup Inc. (C), in return for a special class of preferred shares that gives the government an ownership interest.

But instead of using the government money to resuscitate lending, banks are instead using it to gobble up weakened banks that didn’t get aid.

At the end of the day these buyout deals are bad ones no matter how you evaluate them, says R. Shah Gilani, a retired hedge fund manager, an expert on the U.S. credit crisis, and the editor of the Trigger Event Strategist, a newsletter that identifies trading opportunities emanating from financial-crisis “aftershocks.”

“Why in the name of capitalism are taxpayers being fleeced by banks that are being given our money to grow their businesses with the further backstop of more of our money having to be thrown to the FDIC when they fail?” Gilani asked. “Consolidation does not mean that bad loans and illiquid securities are somehow merged out of existence. It means that they are being acquired under the premise that a larger, more consolidated depositor base will better be able to bear the weight of those bad assets. What in heaven’s name prevents depositors from exiting when the merged banks continue to experience massive losses and write-downs? The answer to that question would be … nothing.”

These new federal measures focus on the wider target – the people and businesses whose collective debt defaults are hampering the lenders. Consumer spending accounts for 70% of U.S. economic activity. So any measures that induce consumers to spend could have an expansionary effect on an economic system that’s widely believed to already be in a recession.

“Nothing is more important to getting through this housing correction than the availability of mortgage finance,” U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. said at a press conference yesterday, Bloomberg News reported. 

And the onslaught on foreclosures have fueled a record decline in home prices, which actually dropped 17.4% in September from a year earlier, according to the S&P/Case-Shiller home-price index. Among the hardest-hit areas, Phoenix and Las Vegas lead with home prices falling 31.9% and 31.3%, respectively, The Wall Street Journal reported.

Miami, Los Angeles and San Diego were close behind, falling 28.4%, 27.6% and 26.3%, respectively.

Declining home and property values are crimping consumer confidence and, hence, spending.

[For a full report on the effectiveness of stimulus packages, check out this related Money Morning report by Contributing Editor Martin Hutchinson that appears elsewhere in today’s issue].

News and Related Story Links:

• Bloomberg:
  Fed Commits $800 Billion More to Unfreeze Lending

• The Wall Street Journal:
  Home Prices Continue to Drop

• Money Morning Investigative Report:
  Billions in Bank Rescue Funds are Fueling Buyout Deals, and not the Increase in Loans That Would Help Ease the Financial Crisis.