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U.S. Stocks Slump As Treasury Bailout Plan Changes Direction

13 November 2008 - Features - Editor

U.S. stocks fell for the third consecutive day with a number of reasons being cited for the continuing decline. For one thing, the U.S. Treasury has shifted the goalposts on the much debated $700 billion bailout plan. Instead of buying up troubled assets from mortgage lenders as originally planned, the focus has moved to consumer credit and shoring up consumer lending. Additionally, news of American Express changing its status to commercial banking in order to avail itself of government aid (see Tuesday November 11 article), sent its shares tumbling by 10 percent. Other factors include the largest electronics retailer in the United States, Best Buy Inc., lost 8 percent after revealing that it anticipates future profits to decrease in the difficult economic climate, and Occidental Petroleum Corporation declined 11 percent due to the price of crude dropping below $57 a barrel.

On Wednesday, Treasury Secretary Henry Paulson said that the government intended to extend assistance to non-bank financial institutions providing consumer credit, including auto loans and credit cards. He acknowledged that in light of the fact that the government will not be buying troubled mortgages and modifying them to assist homeowners, it must come up with other ways to stem the tide of foreclosures. Tuesday’s announcement of a plan to adjust mortgage interest rates or lending terms for mortgages held by Freddie Mac and Fannie Mae is one way that government will be assisting homeowners, but it has been agreed that more must be done as the majority of troubled loans are owned by private institutions.

In the five weeks following the approval of the bailout plan, the Treasury Department has concentrated on injecting capital into banks, which it believes has had the effect of stabilizing the financial system. Paulson was reported as saying that “Although the financial system has stabilized, both banks and non-banks may well need more capital, given their troubled asset holdings, projections for continued high rates of foreclosures and stagnant U.S. and world economic conditions.” He also noted that about 40 percent of U.S. consumer credit is facilitated through securitization of credit card receivables, student loans, auto loans and other similar products. This market, which is considered to be vital for lending and growth, has virtually ground to a halt. These consumer finance companies are suffering because investors are rejecting investments backed by other loans and without investors backing them they either have to curtail their offerings or shut down. This has a ripple effect in that without the consumer finance companies, Americans can’t get credit cards, car loans and student loans. Paulson expressed his confidence that by assisting the securitization sector, lending will get going again, benefiting consumers and supporting the U.S. economy.

There has been a mixed reaction to the shift in focus on the bailout plan, with Wall Street firms expressing disappointment that the Treasury would no longer be buying troubled assets. One of the critical factors resulting from the mortgage meltdown is that because no one wants to buy these assets, it is impossible to attach a price to them. If the government had purchased the distressed mortgage securities, it would have valued them. Analysts believe that until institutions can judge the value of the assets they hold through buyers and sellers agreeing on prices, uncertainty would hold investors back from investing in these assets.

 


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