Before the 1992 Presidential campaign began President George H.W. Bush was considered almost unbeatable. Successful foreign policy developments such as the end of the Cold War and the Persian Gulf War had given him an approval rating of almost 80%. Then James Carville, Clinton's campaign manager, in a moment of inspiration came up with the slogan,'The economy, stupid.' Within a short span of time the attention of the voters was successfully turned towards the economic recession gripping the US at that time, and Bush lost the election.
This time round the outgoing President, the son of George H.W. Bush faces an uphill task to put another Republican in the White House when he leaves.Unfortunately for him the US seems to be stuck in two wars, in Afghanistan and in Iraq, which it is nowhere near winning, although things seem to be improving.Added to this he has an approval rating of 32%.The attention of the American people is once again focussed on one major headline grabbing issue, that is the sub prime crisis and its likely impact on the economy.The government has belatedly woken up to the hard realization that it has allowed matters to drift for too long and that the crisis is going to cast its shadow on the coming elections.
Lawmakers have been facing political pressure to take action.But in September this year the Fed Chairman Ben Bernanke and the Treasury secretary Henry Paulson warned that some solutions could end up perpetuating unhealthy lending practices that created the whole mess in the first place.However some initiatives were taken, such as making more money available in the system to ease the credit crunch,giving borrowers greater protection against predatory lenders and encouraging homeowners to call their banks in order to discuss their problems and find a solution so that they could retain their homes.It was also announced that while the government will try to ensure that people got to keep their homes it would do nothing to bail out speculators or those who were plain greedy.This stand of the government was probably prompted by the assumption that the crisis was nearing an end.But things have simply got worse and there is no immediate end to the crisis in sight. It is now expected that the meltdown will continue well into next year at the very least.
The government had also assumed that the crisis will remain remain confined to the housing sector which accounts for just 5% of GDP and any slowdown there would by itself not affect the economy as a whole.But economics has never been an exact science, although it is good at offering explanations in hindsight. Declining home values seems to be having a wealth effect and Americans seem to be cutting other expenses in order to both make up their losses and also in order to be able to make higher mortgage payments. This is reflected in declining auto sales and even in manufacturing. Consumer expenditure accounts for 72% of US GDP and a slowdown here could tip the economy into a recession.
The Bush administration and the mortgage industry are finally hammering out a proposal to temporarily freeze interest rates on certain stressed sub prime mortgages. If it goes through it will be the biggest action to handle the worsening crisis. The proposals could be in place as early as next week. Talks have involved all the federal banking regulators and major players in the mortgage industry such as Citigroup, Wells Fargo and others. The attempt is to extend for several years the introductory 'teaser' rates that were offered on sub prime mortgages. Such a scheme would however mean losses for investors who have purchased mortgage backed securities as it would reduce the rate of return on their investments. Companies apprehend shareholder lawsuits if they permit modifications in original agreements which are not in the best interest of the shareholders.
Government intervention in times of crisis is not new.People would do well to remember that in 1998, in the aftermath of the Asian flu, when Long Term Capital Management was in danger of going under, it was Alan Greenspan who organized a bail out for it.The economy has grown at a surprisingly strong 3.9% in the 3rd quarter although it is expected to slow in future. Food and fuel prices are at record highs and inflationary pressures are clearly visible.Although interest rate cuts are probably round the corner there are clearly limits to how low Bernanke can go without raising inflation to unacceptably high levels.Moreover he cannot allow the dollar to fall much further else foreign investors may start bailing out of US stocks and treasuries, triggering off a deflationary spiral in the economy.A widespread collapse in asset prices would have a disastrous impact on the economy.These considerations will have to be borne in mind by the mortgage companies and their shareholders alike while considering the proposals put forward by the government.