It comes as no surprise in the financial circle: Federal Reserve Chairman Ben S. Bernanke is set to be nominated by the President Obama to a second term. Having led the economy out of the biggest slump since the great depression, Obama notes that “because of his background, his temperament, his courage, and his creativity”, the Fed Chief is “responsible for preventing another (Great Depression)”.
Pro and Anti Bernanke
Despite Obama’s glowing commentaries and the results of his work in the economy, Bernanke still has to have tough questioning by the Senate. A lot of lawmakers believe that he had been too slow in identifying the severity of the mortgage problem and that he did not protect consumers as much as he has helped struggling financial firms such as the American International Group Inc. and Bear Stearns Co.
Bernanke is already endorsed by the Banking Committee head, Christopher Dodd. According to Dodd, “While I have serious differences with the Federal Reserve over the past few years, I think reappointing Chairman Bernanke is probably the right choice”. Other officials that recommended Bernanke include National Economic Council Chairman Larry Summers, Treasury Secretary Tim Geithner, and Chief of Staff Rahm Emanuel. For his part, Obama wants to reappoint the current Fed Chief because he wanted to keep the team that helped the US weather the crisis to remain intact.
Guiding the Economy Back to Growth
It’s undeniable that there’s still a cloud hanging over everyone’s head because of the financial crisis. In spite of government assurances, it is still definitely not over. A few signs of hope are starting to appear though. For example, Standard & Poor’s 500 Index Futures showed improvement due to reports that the decline in US house prices is slowing down.
The Fed Chief is most noted for slashing the interest rate to near zero and pumping around a trillion dollars into to banking sector. If he is reappointed, he will need to reduce an unemployment rate that is almost 10 percent, guide the economy back to shape, and shrink the Fed’s balance sheet to avoid uncontrollable inflation.
If big banks like Citigroup Inc, Bank of America, JPMorgan Chase, and Goldman Sachs were “too big to fail”, does this mean that less dominant banks should be allowed to fail because they are “too small?” The government seems to think so. The share price of the CIT Group Inc. (CIT) plunged as the company announced that there was very little likelihood that they will receive fresh cash infusion from the government over the near term.
Representatives of the bank scrambled to get a minimum of $2 billion in rescue funding from its current debt holders. As was revealed by CIT representatives to stockholders, there is a high probability that bank might need to file for bankruptcy if it does not receive help. If this happens, the financial market will be tested on its strength and sustainability in financing small and business enterprises (SMEs).
What It Means to the Average Joe Entrepreneur
Individual small business around the country might be “small enough” to fail, but the issue is if they do, they will not go down alone. For example, even small businessmen who are not associated with CIT directly will feel the effects of the bank’s demise if it fails. This is because if their clients, suppliers, and probably even shareholders are drawing credit from CIT, this source of funding will be cut off. There won’t be enough money to pay their partners or buy new products and services.
It is believed that the effects of the bank’s failure will be widespread among small and medium scale businesses. There are around a million small businesses that rely on specialty finance to support their operations. In a 2003 research from the Fed, it was discovered that nonbank lenders account for 28.9 percent of equipment financing, 22 percent of lease financing, and 13 percent of small business credit line.
If companies like CIT cease to exist, small business operations in the United States (accounting for half of the nation’s GDP) is expected to suffer from a bad credit crunch at the time when it is needed the most. The US needs these enterprises to produce, sell goods and services, and hire people to get the country out of recession.
While consumers are thinking how lucky the nation’s largest banks are for being rescued by the government using taxpayer’s money, the banks themselves are regretting their action. Some bank executives certainly aren’t grateful to the government for the “help”. This is because when Hank Paulson and Tim Geithner worked on the $700 billion bailout plan, bankers initially thought that this was designed to jumpstart the economy.
Neither the banks nor the government might have expected the severe public backlash as well as lawmaker’s posturing attitudes that resulted from it. The Troubled Asset Relief Program (TARP) might have made its way through Congress but it came at a very high price. At the meeting where the TARP funds were allocated to the financial institutions, the bankers found out that the Obama administration as changed the plan’s original design. The government will now own a significant share of their banks.
It came as no surprise that some bank representatives balked at the offer. However, Paulson wasn’t taking no for an answer. He believed that leaving the country’s biggest banks at that point in time would leave them exposed. And more failures in the financial sector are bound to spook investors and the public. So certain banks were left with bailout money they don’t want.
Before you think that the TARP money is a bad idea both for the taxpayer and the banks themselves though, it is important to remember that the program did help some institutions greatly. Everyone knows that Citigroup Inc. will no longer exist in its existing structure were it not for the bail-out funds. But some banks are starting to resent having ever receiving the TARP money in the first place.
Around four months after they agreed to the offer, the CEOs of the big banks were asked to go before a House committee where they were called “captains of the universe” to their face by a certain lawmaker. In addition, another one told them that no one trusts them anymore. But the friction between the government and the banks really came to a head during the public outcry regarding AIG’s $165 million in retention bonuses.
Capitol Hill sought to ease public tension by passing a 90% tax on bonuses. With this, the initial good intension of the TARP fund became steeped in bad sentiment. A mere eight months after the TARP was implemented, the banks have already returned $68 billion in total and they are scrambling to pay everything back.
The Federal Reserve took a lot of flak from lawmakers when it failed in its oversight responsibilities and the financial crisis occurred. Now, it seems that the Obama administration is planning to remedy this situation by endowing the agency with the authority to oversee systematic risk. If this plan passes Congress, it will usher in the Fed’s biggest reform in decades. At the same time, the Federal Reserve’s emergency lending capabilities will be limited.
The proposed financial regulation will require the central bank to get written consent from the Treasury before it can give emergency bailout funds. In addition, Obama wants a comprehensive review on how the agency regulates financial companies. In essence, the move is a proposal that aims to prevent regulatory loopholes that result to risk build-up. However, a significant part of the plan requires the approval of Congress where ideological clashes will likely occur. Despite this, the president wants to sign the bill at the end of this year.
New Fed Oversight Responsibilities
Everything from mortgage lending practices to investment strategies will be affected in the government’s across-the-board effort to stop reckless decision-making that helped spark the economic crisis. According to Obama, “we have to have somebody who is responsible for seeing the risk of the system as whole and not just individual institutions.” He added that the “Fed is best positioned to do that”.
Essentially, the plan will overhaul the outdated financial system and make way for fundamental changes. Instead of using a “bulldozer” to clear the path to reforms, senior government officials likened the reforms as restructuring an existing system. It can be likened to an architect’s blueprint for improving an old structure.
Obama’s 85-page white paper outlines the reason why the economic crisis occurred and gave proposals on how these loopholes can be plugged. Among the most notable reasons include the yawning gaps in regulation that allowed banks to lend to borrowers that cannot afford it. Funding these loans can from exotic investments that regulators poorly understood. In addition, problems with executive compensation were also tackled.