The government-engineered bailout of Bear Stearns this past week underscores how concerned our government is about the fragility of our financial markets and the economy. This is the first time since the Depression that our government has stepped up to rescue an individual company in such a dramatic way. The origin of the present crisis can be traced back to the greed of numerous financial institutions all racing to gather profits. They made billions of dollars in home loans to families with sub-par credit who gleefully accepted creative home financing which often included 100% financing, interest-only payments or negative amortization loans. Everything might have worked out if home values had continued to grow as they had over the past decade. Instead, home prices began to fall and as these sub-prime mortgages began to reset at higher interest rates and payments, homeowners began to default on their payments. This past summer, the media began shining a light on the depth and breadth of the sub-prime crisis and the government quickly mobilized a stabilization plan including:
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September 2007. The Federal Reserve changed the direction of interest rates by cutting the Fed Funds Rate by one-half percent from 5.25% to 4.75%. Since then, the Fed has cut rates five additional times, most recently this past week. The Fed Funds Rate now stands at 2.25%. This floods the financial markets with potential liquidity for businesses and individuals assuming the banks are willing to loan out the money.
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February 2008. Amid growing concerns over the possibility of a recession, the government sprang into action with uncharacteristic unity from both sides of the congressional aisle with an economic stimulus package that included $117 billion of rebates to more than 130 million Americans beginning in May. Additional tax incentives are available for businesses making the total package worth more than $150 billion. The government’s assumption is that consumers will take the rebates and head straight to the mall thus stimulating the economy. It remains uncertain whether people will spend the money or use it to pay down debt.
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This past week. The federal government engineers the bailout of financial behemoth Bear Stearns by fellow behemoth JP Morgan Chase & Co. As part of the deal, the government agrees to swap treasury securities for up to $30 billion of Bear Stearns’ most questionable debt securities.
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This past week. Federal regulators ease capital requirements for Freddie Mac and Fannie Mae in an effort to lower mortgage interest rates and provide support for a slumping housing market. Fannie Mae and Freddie Mac together own about 45% of all mortgages in the
United States
What does this mean to you and what should you do now? It’s now quite apparent that the government is very worried about both the financial markets and the overall economy. Consequently, it has taken unparalleled steps to avert an implosion. If you anticipate needing cash from your portfolio over the next three to five years, make sure those funds are parked in the safety of a money market account or other similar instruments. Consider raising any needed cash from your more aggressive stock or stock mutual fund holdings. At this point, it’s impossible to tell whether this storm will continue to intensify or begin to dissipate so a measure of caution is a prudent strategy.