By Emily Kaiser - Analysis
WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson worked the phones and airwaves on Sunday in a bid to reassure financial markets that the government stood ready to help, but he left the heavy lifting to the Federal Reserve.
As Wall Street prepares for what is shaping up to be another tumultuous week, the message from Washington was that the U.S. central bank did the right thing by riding to the aid of Bear Stearns BSC.N on Friday, although the Bush administration still considers “bailout” a dirty word.
The week kicks off with Bears Stearns reporting earnings on Monday, earlier than originally planned, and a meeting between President George W. Bush and his President’s Working Group on Financial Markets. On Tuesday, Fed officials gather to decide how far to cut interest rates.
“Can we outlaw the forces of gravity? You know, how much can government do?” Paulson said in a “Fox News Sunday” interview, arguing that markets must go through a painful correction before they can resume normal function.
That suggests scant White House support for proposals from Democrats Rep. Barney Frank and Sen. Christopher Dodd that would allow the Federal Housing Administration to offer guarantees to help refinance mortgages that banks and borrowers agree to write down.
Indeed, Paulson told “ABC This Week” that proposals calling for major government intervention “do more harm than they would do good” by prolonging the time needed for markets to correct.
Paulson said he was “on the phone for a couple of days straight and throughout the weekend” trying to make sure that financial markets were sound, and he praised the Fed.
In the span of one week, the U.S. central bank announced plans to inject some $400 billion into tight credit markets via two separate programs and provided emergency funding to Bear Stearns, the latest in a series of efforts aimed at preventing fraught financial markets from toppling a fragile economy.
The next step is certainly another interest rate cut on Tuesday. How low the Fed will go remains the subject of intense debate on Wall Street, with the consensus shifting in the wake of Bear Stearns to a more aggressive move — perhaps even a full percentage point.
“These attempts to quell the financial crisis do not give the (Fed) freedom to stand pat on the funds rate target. On the contrary, the pace of rate cuts may need to be accelerated,” Dresdner Kleinwort economists wrote in a note to clients.
“The markets are still in a state of tumult, and the risks to economic growth and employment remain heavily weighted to the downside.”
While interest rates are all but certain to come down this week, what is less clear is what more the Fed and the broader government can do to shore up financial and mortgage markets.
“Even if the Fed’s creative policy responses mitigate the financial market crises, the economy’s basic problems remain,” said UBS economist Maury Harris. “These are a still vast, deflationary overhang of vacant and unsold residential properties and the financial market repercussions of depressed nonprime mortgage-backed securities.”
With turbulent markets blunting the impact of interest rate cuts, the central bank has launched a series of different lending facilities aimed at getting cash where it is needed most. So far, the efforts have had only modest impact on borrowing costs, which remain abnormally high.
That has heightened interest in a broader rescue plan.
Sherry Cooper, global economic strategist at BMO Capital Markets, said this year’s U.S. presidential election meant “everybody has to have a proposal and a solution” to the mortgage mess and financial market unrest, but with the White House resistant to anything resembling a bailout, it was unlikely that a dramatic plan would emerge.
“I don’t think that this is going to end up being a taxpayer bailout. I just don’t think that ... people have the stomach for that,” she said.
Deutsche Bank economist Mustafa Chowdhury said the government’s power was limited, noting that the Fed’s latest $200 billion lifeline was a drop in the bucket compared with the $11 trillion on U.S. bank balance sheets.
“The federal government can ill afford a sizable purchase of mortgages, given wider budget deficits which started at around $150 billion last year and could very well reach $600 billion this year if a recession takes hold,” he said.
Chowdhury likened the Frank and Dodd proposals to a leveraged bet on housing that had no guarantee of paying off.
“The kinds of measures that require substantial fiscal outlays, such as this mortgage purchase plan or an explicit guarantee of agency mortgage-backed securities, require significant political commitment and consensus which is absent right now,” he said.
Additional reporting by Donna Smith and Andy Sullivan; Editing by Tim Dobbyn