Still Working to Restore Confidence
By: Dr. Charles Lieberman
Date: 12/1/2008
Paulson's approach to unfreezing the credit markets is still evolving, now to include GSE debt purchases in addition to bank recapitalization by the Fed. Progress achieved in the shorter maturity markets must be extended to the longer maturities, most critically for corporate credits. As long as healthy firms cannot be confident maturing bonds can be rolled over, the credit crisis can worsen, extending the recession. Thus, while some financial market conditions are improving, it is way too soon for policymakers to sit back and await the incoming Obama Administration. Rather, purchases should include commercial mortgage securities, not just residential mortgages. And the Fed must find a way to feed investment dollars into the corporate bond market, at least for investment grade credits, until private capital follows suit.
Treasury's decision to put up $20 billion in risk capital from TARP to enable the Fed to purchase as much as $600 billion in GSE paper to help the mortgage market was very effective in reducing mortgage rates. (Former Fed Vice Chairman Alan Blinder is correct, however, that Paulson could have accomplished the same objective more easily and earlier by just explicitly guaranteeing GSE debt.) This action will be very beneficial in two ways; it will reduce the cost of home purchases, helping the housing market recover sooner, while it will also enable many households to refinance, lowering their monthly mortgage cost and increasing discretionary income. It would have been even more powerful had Treasury just guaranteed GSE debt, while putting up the same $20 billion to enable the Fed to buy a few hundred billion in commercial mortgages.
The corporate debt market remains frozen, as firms have difficulty rolling over maturing debts and quoted rates remain exceptionally high. The threat of widespread default will remain high until these conditions return to normal. Nor can a sustained economic recovery develop while ordinary financing is anything but routine. Paulson has stepped up his support for credit markets, but far more needs to be done. Fed purchases of asset-backed and high-grade corporate bonds would help considerably in restoring credit market conditions to normal.
While we wait for Paulson's Treasury to recognize the need for a broadly based interventionist strategy, the Fed will surely cut rates again next week, likely by another 50 basis points, following rate cuts by the Europeans this week. We will know conditions are improving if we see new debt issuance increase on reasonable commercial terms. Download this article in PDF Format
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Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
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