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Where angels fear to tread

Wed, Nov 26 2008, 09:25 GMT
by Yapi Kredi Bank Economic Research Department

Yapi Kredi Bank

Today’s announcement of new unprecedented steps by the Fed in coordination with the US Treasury underscore that efforts to limit the depth and length of the recession will live or die by their ability to revive private consumption. Where angels fear to tread, the Fed is de facto stepping in as lender to consumers and small businesses and as buyer of mortgage-backed securities to improve mortgage financing. The two steps in combination should prove effective in cushioning the collapse in private consumption and help a gradual recovery later next year. The UK’s stimulus package, centered around a significant temporary cut in VAT rates, is also clearly focused on consumption and in this respect well-targeted. Signals from European policymakers have been more mixed. The European Commission will announce tomorrow a proposed coordinated EU-wide fiscal stimulus, but official statements so far raise the fear that the fiscal policy response could be insufficiently bold and coordinated. European governments are very aware of the importance to signal commitment to fiscal responsibility. They should however be mindful that a sharp and prolonged recession would also put pressure on budget deficits and debt to GDP ratios. The global economy needs fiscal stimulus, as coordinated as possible and focused on measures that can give an immediate boost to growth and can more easily be reversed.

With the launch of yet a new facility, the Term Asset-Backed Securities Loan Facility (TALF), the New York Fed will extend 1-year non-recourse loans against new or recently originated ABS backed by auto loans, student loans, credit card loans or small business loans guaranteed by the US Small Business Administration (with collateral haircuts to be determined for each eligible class of assets). The total amount in play is USD200bn, with the first USD20bn provided by the Treasury through the TARP. The range of ABS targeted could later be expanded to include other asset classes, including commercial mortgage-backed securities and non-Agency residential mortgage backed securities.

Where angels increasingly fear to tread, the Fed has no choice but to rush in, to halt and reverse a contraction of credit to households and small businesses that threatens to make the recession even deeper. The main target of the new facility is the US consumer, with ABS accounting for about one quarter of total consumer credit outstanding (nearly 50% for credit card loans and about 13-14% for car loans). My colleague Harm Bandholz has highlighted the recent sharp rise in credit card delinquencies, and the concomitant collapse in related ABS, leading to a plunge in the rate of growth of revolving consumer loans. With the housing market still contracting and the labor market facing a further deterioration (during previous recessions, unemployment peaked at 7.8% in 1992 and 10.4% in 1983), US consumption needs all the help it can get. Lower commodity prices are clearly not enough yet, and as we wait for a new bold fiscal package it had become imperative to prevent a further deterioration in credit conditions.

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Published on  Wed, Nov 26 2008, 09:25 GMT