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Archive for Wednesday, July 16, 2008

Analysis: Leaders running out of options

July 16, 2008

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¢ Wholesale inflation, driven by skyrocketing gas and food costs, rose by 9.2 percent for the 12 months ending in June - the fastest pace since the summer of 1981, during another energy crunch, the U.S. Labor Department said Tuesday. Also, retail sales turned in their poorest showing in four months.

¢ Oil prices fell harder than they have in 17 years Tuesday, as fears that record fuel prices are spreading broad economic pain exacerbated the third big sell-off in just over a week. Light, sweet crude plunged $6.44, or 4.4 percent, to settle at $138.74 a barrel in an extremely volatile session.

— The nation's leaders are running out of answers to America's economic crisis.

The Federal Reserve has no more practical room to push interest rates lower; there's only so much taxpayer money for shoring up housing, and if depositors lose confidence there's little officials can do to stop a run on banks.

President Bush, speaking from a White House podium, and Federal Reserve Chairman Ben Bernanke, in testimony to a congressional committee, sought on Tuesday to soothe jittery markets and reassure Americans that the U.S. financial system remains basically sound despite the current turmoil.

But they both tempered their remarks with warnings and expressions of uncertainty.

Bernanke warned that the U.S. economy faces "numerous difficulties," that the outlook for inflation is unclear and that "financial markets and institutions remain under considerable stress."

Bush told a news conference: "The president doesn't have a magic wand." He was answering a question about soaring fuel prices but his remarks seemed to sum up the government's overall predicament.

After years of seeming tame, inflation is again on the rise, led by higher food and fuel costs. But the Fed, which usually fights inflation by boosting interest rates, finds itself unable to use that weapon any more - it already has pushed rates down to 2 percent from 5.25 percent in response to the housing crisis - without threatening to undermine an economy that is either in recession or growing anemically.

With soaring budget deficits, swollen from the costs of wars in Iraq and Afghanistan and increased spending on homeland security, there's only so much taxpayer money for bailing out failing financial institutions.

Stocks are in a bear market, and shares of banks and other financial companies have been pounded.

"I fear that we're sitting on a financial powder keg," Bernanke was told by Sen. Richard C. Shelby of Alabama, senior Republican on the Banking Committee.

Mortgage giants Fannie Mae and Freddie Mac hold or guarantee about half the home mortgages in the United States. Their stocks have lost about 80 percent of their value over the past year. Over the weekend, the two were thrown a lifeline by the Treasury Department and the Fed. But if investor jitters prevent them from being able to sell bonds to finance new mortgages, it could have far-reaching economic consequences.

And the risk of runs on banks is still present, although minimized by federal deposit insurance on accounts up to $100,000 and by other federal safeguards.

Regulators seized IndyMac, a large California-based savings and loan bank, on Friday after hundreds of depositors lined up to withdraw funds at branches. The bank reopened Monday under federal control.

Bush counseled calmness. "I happened to witness a bank run in Midland, Texas, one time. I'll never forget the guy standing in the bank lobby saying, your deposits are good. We got you insured. You don't have to worry about it if you got less than $100,000 in the bank. The problem was, people didn't hear. And there's a ... nervousness. My hope is, is that people take a deep breath and realize that their deposits are protected by our government."

But nearly $1 billion of IndyMac's approximately $19 billion in deposits was uninsured, according to the Federal Deposit Insurance Corp.

The administration unveiled a U.S. rescue plan for Fannie Mae and Freddie Mac, but it has not put a pricetag on it. Treasury Secretary Henry Paulson said the administration did not intend to nationalize the companies and wanted to preserve their shareholder-owned structure. Still, he said a regulatory overhaul was needed.

Congress is also working on legislation that would modernize the Federal Housing Administration and create a new regulator and tighter controls for Fannie Mae and Freddie Mac.

If the government wound up taking over the two companies, it would have to assume more than $5 trillion in mortgage debt that the two companies now either own or back. That would add to a federal debt fast approaching the $10 trillion mark.

Bernanke defended the Fed's decision to help rescue Bear Stearns as well as Fannie and Freddie. If problems aren't contained, they can ripple throughout the economy, hurting everyone, he said. "Financial stability is critical to economic stability."

David Jones, an economist at DMJ Advisors and a longtime Fed watcher, said Bernanke's testimony suggested that the Fed's "emphasis has shifted to financial stability," perhaps signaling that it will leave interest rates unchanged until late 2008.

There are some things that could be done, but they may not be politically viable.

Democrats in Congress want to pass a second economic stimulus package, but it is being resisted by Bush and many congressional Republicans.

House Speaker Nancy Pelosi has urged Bush to release oil from the government's Strategic Petroleum Reserve to knock down gasoline prices. Bush repeatedly has rejected such calls to use oil from the reserve, which holds about 702 million barrels of oil - enough to replace imports for two months. The crude oil is stored in caverns in Louisiana and Texas. Recently, Bush reluctantly agreed to halt shipments of about 70,000 barrels of oil a day into the reserve after Congress directed him to do so.

In any event, voters don't seem to have much confidence in either Bush or Congress.

The approval rating of Congress is down to a new low of just 18 percent from 23 percent last month, according to a new AP-Ipsos poll. Bush's approval is at 28 percent, about even with the 29 percent rating last month.

Only 16 percent of those surveyed thought the country was moving in the right direction, a new low as well, although statistically the same as last month's 17 percent.

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