AGA Today

Wider Confidence Lifts Economy From Winter's Deep, Dark Freeze

By Neil Irwin and David Cho
Washington Post Staff Writers
Thursday, May 21, 2009

The financial system, frozen solid for the past nine months, is in a spring thaw. And it's happening even though many of the Obama administration's major rescue programs have yet to get off the ground.

The improvement reflects the combined impact of a wide range of actions, many of them taken with little public attention, according to government officials and private economists. But more important than any single program, the sources say, is a deepening confidence from financial markets that the government is prepared to take aggressive action -- a confidence that Obama officials have repeatedly worked to cultivate in speeches and public appearances.

Since early this month, major banks have raised or said they would raise $56 billion in private capital -- the type of surge that Federal Reserve Chairman Ben S. Bernanke said in March would signal the financial system is recovering. The premium that banks charge to lend to one another, another sign of the system's health, is at its lowest level since the financial crisis began in 2007, based on one key measure.

The Standard & Poor's 500-stock index is up 34 percent since March 9, and a measure of stock market volatility this week hit its lowest level since the financial crisis deepened in September, indicating that investors think the market's wild gyrations will be more subdued.

Stabilization of the broader economy has helped the financial sector right itself. In minutes released yesterday from their April policymaking meeting, Fed leaders said the economy could begin to pull out of the recession later this year.

But they and private economists caution that the unemployment rate is likely to remain elevated through at least 2011, that people could continue to pull back on spending as they save more and borrow less, and that businesses must grapple with a glut of investments from the boom years.

"The feeling is that for now we've avoided the Great Depression," said Anil Kashyap, an economist at the University of Chicago Booth School of Business. "But the real economy is still in pretty bad shape."

The relative improvement has come despite sluggish progress in some of the more high-profile government efforts to revive the financial system and the economy.

The Fed's $1 trillion program to support consumer and small-business lending has deployed less than one-fiftieth of that amount. An Obama administration plan to buy troubled assets off the books of banks is roughly six weeks from operating, Treasury Secretary Timothy F. Geithner said yesterday in congressional testimony. Aid to small businesses and homeowners facing foreclosure has not yet flowed in large volumes, nor has money from the government's economic stimulus plan, passed in February.

Still, government officials and private economists say, there's a sense that the government is attacking the crisis from all directions.

"They're doing a whole bunch of things in a lot of different markets to provide support," said Desmond Lachman, a resident fellow at the American Enterprise Institute, a Washington think tank. "And markets look forward, and to some degree improve in anticipation of measures that are to come."

The idea of trial-and-error, and rolling out many different policies before the details can be figured out, has been a guiding element of the Obama administration's strategy.

"A huge part of getting out of this crisis is about confidence," Geithner said in a recent interview with The Washington Post. "And it's the impressions, the impacts, not just by the quality of policies themselves, but by the sense of action by the government . . . that's critically important to confidence."

Taking on so many initiatives has come with a cost, both by diluting the administration's focus and putting vast sums of taxpayer dollars at risk. Critics worry that the administration has no clear long-term plan for winding down its bailout.

The Treasury Department's $700 billion Troubled Assets Relief Program, which Congress approved in October, has to date been fully deployed only for government investments in banks, rescues of major automakers and the bailout of American International Group.

But a broad range of less prominent actions have had a more immediate impact.

For example, the Fed cut short-term interest rates to essentially zero in December, which aside from making it cheaper for Americans to borrow money has helped banks replenish their depleted capital. Banks make money off the spread between what they pay depositors in interest and the interest they charge on loans, and lower short-term rates have widened that spread.

A Federal Deposit Insurance Corp. program to guarantee bank debt enabled banks to continue funding themselves through the darkest days of the financial crisis. And Fed programs to buy $1.75 trillion in mortgage-related securities and U.S. government bonds have helped push down interest rates across the board, especially for those buying or refinancing a home. Another Fed program stands ready to back markets for commercial paper, a form of short-term debt for large companies, though use of the program has dwindled in recent months as the commercial paper market has stabilized.

"I can't imagine we'd be in the shape we're in had there not been such active government policy," said Martin Neil Baily, a Brookings Institution senior fellow and economic adviser in the Clinton administration.

There remain considerable risks that financial strains will return, and loans are hard to get outside of government-supported programs. For example, the Fed is buying packages of mortgages funded only by government-sponsored housing finance firms like Fannie Mae and Freddie Mac. Mortgages not funded by those companies still have high rates and are hard to get.

It is unclear what will happen when some of the government programs that have been put in place are taken away. For example, even though the Fed's commercial paper program is not used much now, buyers of commercial paper may be more willing to make those investments knowing the program exists.

The positive signs are "all welcome news," Geithner said, "but I want to emphasize this is just the beginning. The cost of credit for businesses and families is still unusually high, remarkably high. Credit terms are very tight still. Bank lending is falling to both consumers and businesses."