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Income Gap Shrinks Between the Rich and Poor in the US

With the deepest recession in the US economy since the Great Depression, the income gap between the well-off in the United States and the average American is becoming to shrink. Ideally, this gap should be closed by lifting up the bottom. But in the trend being seen today, it is shrinking because the top is being pulled down.

According to Ariell Reshef, an economist from the University of Virginia, “Based on experience, it looks like inequality will go down and change the long-term trend of America being a less egalitarian society.” Over the last three decades, individuals occupying top positions as chief executives, law-firm partners, Wall Street bankers, and savvy traders have amassed huge amounts of money. Meanwhile, the income of teachers, office managers, factory workers, and other individuals working in the middle grew slowly.

It is estimated that in 2007, the top 1 percent of US families controlled 23.5 percent of all personal income in the United States. The share of that 1 percent is shrinking fast. It is believed that their income will drop to between 15 to 19 percent of all personal income by 2010.

One significant development that can be seen is the drastic cut in pay for chief executives. In 2008, the median salary of executives listed in the S&P fell 15 percent. However, the effects of the economic crisis and the succeeding credit crunch will go deeper than that. Saving money, for example, has become an important part of an average America’s life.

Finance, for its part, has previously been seen as a lucrative job that attracts top talents. It will not be this way in the future because it will make up a smaller part of the overall economy. The behaviors of Americans will also change. Because borrowing is becoming harder, the focus of many would be debt relief to avoid high interest payments. In any case, there is no doubt that the developments in the last two years will be seen as a watershed for the country’s economic life and American’s lifestyles.

Bernanke Needs to Assure Jittery Market

Having invested $1 trillion into the economy, Chairman Ben Bernanke now faces the daunting task of convincing investors that the Federal Reserve can make up this amount. Bernanke and his colleagues are set to agree, on June 23-24, that the government needs to continue its strategy of buying assets in order to maintain low interest rates. Though this is geared to revive growth, the rising Treasury bond yield are indications that investors are concerned that sustaining such a strategy will lead to a long-term inflationary pressure.

According to Lyle Gramley, an economic adviser from Soleil Securities, “markets don’t understand the Fed’s exit strategy” and this is a cause for concern. This confusion contributed to the higher rates in long-term investments. The risk in having higher rates lies in the fact that it will hinder economic growth by lifting the cost of borrowing for home buyers.

Mounting Mortgage Rates

Earlier this month, the average mortgage rate for a 30-year loan actually rose to 5.59 percent which is the highest since November of last year. Because of this, the number of mortgage applications dropped to 16 percent in the week ending June 12. The Mortgage Bankers Association also revealed that the increase in rates had discouraged refinancing.

How the Fed Plans to Contain the Cost

Fed officials are looking at many options to contain borrowing costs in the market. Right now, it seems that they want to use policy statement to stop speculations that they’re prepared to boost the interest rates this year. According to a the chief economists at the Bank of Tokyo-Mitsubishi UFJ Ltd. located in New York, everyone is thinking of the exit strategy because they are “worried about the future”.

If policy makers intend to restrain rates, they need to explain how they can prevent inflation from growing at an uncontrollable pace. It is not only the US that has to deal with this problem though because there are also talks in the European Central Bank on how they can reverse their stimulus.

Unless the Fed provides clarity on its exit strategy, investors, analysts, and even the public will conclude that the back-up in interest rates will create problems in refinancing and housing in the future. And there is a high chance that it will.

Banks to Undergo Management Review

Over the past few weeks, news has been buzzing that nine of the country’s largest banks that failed the stress test are undergoing capital-raising initiatives to meet the government’s criteria. Monday is scheduled to be deadline for federal bank regulators’ approval for these plans. This long-awaited moment can be outshined by a less known deadline though: management review of these banks.

Banks including Citigroup Inc. and Bank of America will assess their top executives to ensure that the banks have sufficient leadership capability that will take them through the tough times. According to regulators, this process is necessary to find out if the current management has the “ability to manage the risks presented by the current economic environment”.

For many, this management review seems confusing, if not unnecessary. This is because the rules of the management review remain unclear. And individual regulators are providing contradictory guidance which further confuses the process. Whatever way they call it, it is clear that federal regulators are simply pressuring banks to get more people with commercial banking expertise.

Bank of America has already bowed to the pressure by replacing one senior executive and several directors. For its part, Citigroup is beefing up its board by adding new directors. It remains unclear if federal regulators will approve the management review on its deadline, which is on Monday.

Even as “weaker” banks prepare to wait for government approval for their capital raising initiatives and management review approval; “stronger” banks like JPMorgan Chase & Co and Goldman Sachs Group are preparing to repay the government. If their repayment scheme is approved, this will spell a dramatic milestone in today’s chaotic financial market.

It is expected that the government will accept the repayment of these banks. The Fed previously announced that it will allow repayment if the banks can prove they can raise capital from outside investors and lend to borrowers without relying on federal support.

China Pressures Washington

In this entry, we will discuss the pressure China is putting on Washington regarding the stability of their investments in the U.S. economy. Below, we will take a closer look at the investments China has in the form of T-Bills, as well as the reasons why they have recently expressed concern.

China is the United States’ biggest investor. With about $1 trillion in U.S. Treasury bonds, along with other forms of investments, it is to be expected that China is inquiring about America’s financial situation. This past Friday, China’s premiere, Wen Jiabao, asked for a guarantee that China’s investments will be safe. “We have a huge amount of money in the United States. Of course we are concerned about the safety of our assets.”

So why exactly is China concerned? Well, it’s no secret that the recession in the U.S. economy is apparent to the rest of the world. With the increase in government spending, the U.S. continues to print more and more money. What could result is inflation, which would then cause the U.S. dollar to collapse in value. As the largest holder of America’s public debt, China needs to feel confident that its investments are safe.

President Obama responded to Jiabao’s concern with confidence, commenting: “And so I think that not just the Chinese government, but every investor, can have absolute confidence in the soundness of investments in the United States.” Obama feels that the stability of the U.S. economy, along with its political system, has enabled China’s investments to continue, despite the financial crisis.

So what would happen if China pulled its investments, despite President Obama’s reassurance? Well, if China sold its treasury holdings, the value of the U.S. dollar would fall. As a result, borrowing costs in the U.S. would increase. China may be hurt in the end, as it would then be more difficult for Americans to buy Chinese goods.

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