Even though economic statistics continue to indicate that growth will slow considerably between now and the end of the year, efforts by the Federal Reserve and other government agencies to alleviate the credit crisis and stimulate the economy will likely provide a floor of support in stocks for at least the next few weeks.
Last week, the Fed provided $75 billion worth of U.S. Treasury securities to investment banks in an effort to help those financially-strapped institutions gain access to needed capital. In other words, the Fed swapped $75 billion of its AAA-rated Treasury securities for risky mortgage-backed securities and other lesser-quality debt holdings under the guise of its new lending facility — the Term Securities Lending Facility (TSLF), which was created on March 11, 2008.
The creation of the TSLF gives struggling investment banks the ability to easily raise financing by using Treasuries as collateral rather than risky debt. After all, selling Treasury securities backed by the full faith and credit of the U.S. government is much easier than unloading mortgage-backed securities.
With the creation of the TSLF, the Federal Reserve now has six tools for implementing monetary policy:
(1) The buying and selling of Treasury securities in the open market (Open Market Operations)
(2) Lending money directly to commercial banks via the Discount Window
(3) Raising or lowering the amount of funds that commercial banks must maintain at the Federal Reserve Bank (Reserve Requirements)
(4) Providing loans to commercial banks via the Term Auction Facility (TAF) for up to 28 days in exchange for a broad range of collateral (such as mortgage-backed securities)
(5) Lending U.S. Treasury securities to investment banks via the Term Securities Lending Facility (TSLF) for up to 28 days in exchange for mortgage-backed securities and a broad range of other debt securities
(6) Lending of funds to investment banks for up to 90 days via the Primary Dealer Credit Facility (PDCF) in exchange for mortgage-backed securities and other debt securities
The TAF was created by the Fed on Dec. 12, 2007, while both the TSLF and the PDCF were created during mid-March.
Yesterday morning, Treasury Secretary Henry Paulson proposed the broadest overhaul of U.S. financial regulation since the Great Depression, saying that the system for overseeing American capitalism needs to be better prepared for "inevitable market disruptions."
Paulson also said that the Fed should expand its oversight of financial services beyond banks by monitoring corporate disclosures, writing rules, and implementing measures to prevent economic crises, such as making loans (when needed) to federally-chartered insurers and other financial institutions.
These government initiatives may, in fact, mitigate the impact of the ongoing credit crisis and help restore investor confidence in the functioning of the financial markets. However, those actions will have no impact on the continuing slump in the housing market, and they will do nothing to improve the deteriorating employment situation. Nor will the government's tax rebate stimulus package replace the lost incomes from recent job cuts or help consumers put a dent in their huge debt loads.
Therefore, I expect the U.S. economy to continue growing at an anemic rate, at best, over the next couple of quarters and for corporate profits to fall during the months ahead.
I urge you to not get overconfident about the actions being taken by the Fed and other government agencies. Keep in mind that the government took similar steps after the stock market crash of 1929. Yet, stocks fell dramatically between May 1930 and July 1931, after rallying sharply from November 1929 through April 1930. Click here if you'd like to learn how to profit during the current investment environment by investing in the right ETFs.
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