As the nation's focus turns away from Pennsylvania Avenue and back on Wall Street, the latest news from the center of the nation's Financial District has been found to be not been promising.
???Although the stock market has weathered boom and bust cycles before, the current debacle is something unprecedented. The latest buyouts and failures of commercial banks have yet to restore the American people's faith in the U.S. financial system.
???"Despite the gloomy assessment of the economy at the moment, there is one reason to be optimistic: business cycles eventually end. This is why they are called cycles," said Isaac Ehrlich, chairman of the Department of Economics.
A nationalized bank
???Recent media speculations have theorized that Obama's administration will take a hard look into saving the finance industry from certain doom and gloom.
???They are still discussing several options including creating a "bad bank" that would nationalize the worst performing loans by taking them off the books of financial institutions without fully taking over banks.
"The $8.29 billion loss posted by Citigroup last week along with the second injection of funds to the [Bank of America] and the plummeting of stock prices of practically all banks raised speculation that the government may need to nationalize insolvent financial institutions as a means of jump-starting the financial industry," Elrich said. "The allure of complete, long-term nationalization is that full ownership by the government can avoid the need to value and buy toxic assets."
???Many believe that the government should not get involved in private economic activity.
???"The downside is having the government engage in entrepreneurial and resource allocation decisions for which it has no relative advantage," Erlich said. "In fact, the federal government's role in the mortgage operations of Fannie Mae and Freddie Mac is one of the major reasons for the mortgage industry mess we are in today."
Obama's Stimulus Package
???President Barack Obama has wasted no time in promising to take action to alleviate the public's current troubles.
???With the stimulus package, Obama plans to replace jobs and lay down 3,000 miles of transmission lines for a national electric grid, secure 90 major ports, and safeguard health insurance for 8.5 million Americans in danger of losing coverage.
???Some argue that this is the most severe contraction since World War II and monetary stimulus from the Federal Reserve has not yet been felt.
???"The longest post-WWII recession, the 1982 contraction, lasted 17 months," Erlich said. "The current recession is already a year old and will probably last longer. But we do not know how deep it would be. In 2008, the economy lost 2.6 million jobs, and another 2 million jobs may be lost in 2009."
???The unemployment rate, which was at 7.2 percent last month, has not yet reached the 1982 level, when unemployment reached 10.8 percent.
???"The Obama team employs a Keynesian approach, which assumes that increased government spending has a multiplier of 1.5, meaning that any $1 billion in spending will generate $1.5 billion in real production," Elrich said. "This is how they infer that the package will generate 3 to 4 million new jobs."
???Still, according to Erlich, the increased spending may not affect the job market in the way that the Obama administration hopes it will.
???"The spending programs include a substantial amount in aid to states for projects that have limited impact on job creation, such as $87 billion in temporary Medicaid spending," Erlich said. "These may do little to enhance employment. Also, any employment gains resulting from the $90 billion allocated to infrastructure spending will not show up until late 2010."
Feds buying long-term bonds
???In another attempt to free up the money markets, the Fed has announced it will begin buying long-term treasury bonds. This has never been attempted. Normally when it buys treasury bonds it is for the short term.
???By buying long-term bonds and corporate bonds, the Fed is attempting to drive up their prices, making them more valuable, theoretically injecting money into the economy. Another option it could have chosen would have been to lower interest rates, but they are already close to zero.
???"In its meeting on Jan. 28, the Fed therefore decided that it will pursue further unconventional steps to try to stimulate the sagging economy by buying long-term T-Bonds as a way to pull down long-term interest rates," Elrich said. "Having the Fed as a buyer could keep longer-term Treasury yields from rising in the face of the record sums the government is expected to borrow this year to finance bailouts of the financial system and economy and stimulate the economy."
???There is no guarantee that this will work because these methods are new in monetary policy.
???"In fact, one reason for being skeptical about the need for too large a fiscal stimulus package is that with all the liquidity that the Fed has already injected to the financial sector, sooner or later this will repair the balance sheet of banks and increase their willingness to lend money to investors," Erlich said.
Photo: Courtesy of Laron Fomby
