The Federal Reserve gave the economy another teaspoonful of tonic last week, and investors gulped it down.The hope is that it will cure what could ail the economy and keep the doctor away.
But it's too early to expect a clean bill of health. The incubation period for economic remedies and problems is often six to 12 months, and the economy could be sickened by more than tumbling home prices and the potential that house-poor consumers might not spend much.
There remains a hangover from the summer's credit crunch and ongoing weakness and mistrust in the financial system. The nation's largest banking firms have been reporting the damage they caused themselves and investors by cavalierly creating securities backed by undependable subprime mortgages.
Those securities, which were based on homeowners making mortgage payments on time, plunged in value when it became undeniable this summer that many would not be able to make their payments. And the securities, along with others suffering guilt by association, continue to be shunned by investors because they were based on weak analysis about the mortgage market.
"There is a lot of supply and not a lot of demand because investors are mistrustful of the process," said Janet Tavakoli, president of Tavakoli Structured Finance. The breakdown in trust that Wall Street brought about through lax lending and underwriting standards, along with secretive accounting, cannot be cured by interest rates alone, she said. "People didn't think: Can people pay these back?"
The lack of diligent analysis continues to be a drag on banking profits and the willingness of lenders to take a chance on lending money to entities that could have secret financial problems lurking beneath the surface.
Even traditionally safe commercial paper, which finances essential short-term borrowing by various types of businesses, is now suspect because much was backed by mortgages.
You can see the lingering mistrust in banking stocks like Merrill Lynch's, which has dropped sharply this year. You can see it in the $27 billion in write-downs large investment banks have taken on mortgage-related securities and leverage loans.
"We clearly need more transparency," Moskow said, as he laid blame for the recent credit crunch in multiple directions.It started, he said, by lenders changing the rules of lending--financing 100 percent of the costs of borrowing a home by using such strategies as piggy-back loans, in which the borrower takes out more than one loan.
Then, Wall Street bundled the flimsy mortgages into securities and sold them widely without alerting people to the risks. Rating agencies, such as Moody's and Fitch, also failed to analyze the risks or warn investors about them, Moskow said.
"It's important that people have confidence in the numbers firms put out," he said. "We have depended on rating agencies, and they have got to step up their effort to do a better job. We need to examine the role of the agencies and conflicts of interest."
As Wall Street churned out hundreds of billions of dollars in mortgage-related securities the last few years, rating agencies gave the safest ratings of AAA to many that, in retrospect, were not that safe. During the last few months, the agencies have said they need more reliable data than they have had. They have evaluated their analysis and marked down ratings.
For example, Fitch reported recently that of 431 structured finance collateralized debt obligations representing about $300.1 billion of outstanding debt, 150 are now showing signs of greater risks than were first assumed. The questionable securities represent about $36.8 billion in debt obligations.
When securities like these are downgraded, investors won't pay full price for them. Prices drop in the marketplace. Given the continued uncertainty about the underlying analysis and value of the mortgage-related securities, investors are reluctant to touch them. And prices are spiraling down.
In fact, some securities held in bank-related structures known as structured investment vehicles, or SIVs, are so troubled that the U.S. Treasury Department has stepped in to help large financial institutions such as JPMorgan Chase, Citigroup and Bank of America form their own rescue plan.
The idea would be to place the declining securities in another institution--known as a super SIV--so confidence could grow and lift prices of the securities. Presumably, that would help prevent the institutions from taking losses.
Moskow, as well as former Federal Reserve Chairman Alan Greenspan, has raised questions about the wisdom of the plan.
Yet Moskow noted there is concern that without a solution, banks might have to take larger write-offs and that "could restrict credit availability."
In other words, banks would cut back on granting loans--potentially a crippling effect on the economy.Tavakoli notes that one of the troubles in the system now is that investment banks are "denying their losses. That's shaken confidence."
Interest rate cuts don't solve those problems, she said: "The markets can deal with a lot, but not cover-ups. It shakes the markets' confidence, and we have a long way to go in coming quarters."
Gail MarksJarvis is a Your Money columnist. Contact her at firstname.lastname@example.org.