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‘We aren’t going to get out of this overnight,’ commissioner says

The federal government has pledged $700 billion to invest in troubled banks in the country with the intention of unfreezing credit markets. But there have been concerns about some banks hoarding the money or spending it for other purposes instead of using it to make loans to keep the country’s credit markets open.

The bailout didn’t require banks to put the money back in circulation, and one bank used the money to purchase another bank. PNC Financial Services, which will get $7.7 billion by selling preferred shares to the U.S. Treasury, bought National City in a $5.58-billion deal. Critics said PNC in essence bought National City with taxpayer’s money.

“It certainly appeared PNC used some of their bailout money to buy a bank in Ohio,” said Mississippi Banking Commissioner John S. Allison. “Everyone got kind of exercised about that. The bailout money is supposed to be used in the community to free up some more credit.”

No Mississippi banks received money in the first round of government bailout money. But some of the state’s bank have made inquires about the second round.

“You have to be a well-capitalized institution, a number one- or two-rated institution, to qualify for it,” Allison said. “We have some banks in the state that have looked at it. The rules of the money are fluid. Some things are changing about what banks can do when they get the money.”

Allison said allegations of hoarding the money have been made, and rules about receiving the money may be modified to address that issue.

There have obviously been some cutbacks in new loan activity in Mississippi.

“From what I understand in talking to the bankers, it is still kind of tight,” Allison said. “But if you go back to the traditional qualifications for loans such as definite income from the project, some collateral and a down payment — some skin in the game, if you will — you can still get a loan. Some credit limits have been reduced. It isn’t totally free flow, but there is availability out there.”

Fewer people are applying for loans. Businesses are cautious about expanding during an economic downturn. Most people are in a “wait and see” mode. Businesses are forgoing expansions or renovations until the economic climate improves.

‘More traditional way’

“Unless you really need a loan for a small business, people are not even asking for money,” Allison said. “Long range, I think everything is going to get back on track. But it is going to be a more traditional way of doing business. I know in the mortgage industry, there won’t be any more exotic products such as 100% loans or loans with no verification of income. But if you have money for a down payment and income, there are some good buys in the housing market now.”

While Mississippi hasn’t totally escaped a slowdown in the real estate market, Allison said real estate has not been devalued as much as in other areas of the country where prices were greatly inflated.

There is no doubt this generation of Americans is facing unprecedented times of economic turbulence.

“But in the history of America, we work our way out of things,” Allison said. “We just have to let the free market work. The safety nets are in place, but they need a chance to work. We didn’t get in this overnight and we aren’t going to get out of this overnight. The next administration is going to be a saddled with some hard choices about what they can do and a game plan to carry it out. It is not going to be easy. If the right steps are taken to really solve the problem, a lot of people will be upset about it.”

The problems with the economy are magnified by the huge loss of wealth in the stock market combined with depressed home prices. A lot of people store their wealth in their homes. With home values in some cases declining to less that what is owed on a mortgage, people aren’t in a position to spend or invest, said Dr. Phil Malone, chair of the finance department at the University of Mississippi.

“That is bad for consumption, but also bad for investment purposes because a lot of people simply don’t have the money to invest at this point,” Malone said. “Folks don’t have as much to invest because a lot of wealth was destroyed. That is going to make it hard for some companies to borrow money. It affects people making large investments, especially risky investments in small firms. If you don’t get new investment, you don’t get new job creation like you would otherwise.”

It is a two-fold problem. It will be harder for businesses to get loans because people don’t have as much to invest. And risk premiums are likely to go up, making it more expensive to borrow money.

“Some decent things have happened with the Federal Reserve keeping interest rates down, but the Fed can’t do anything about the risk premium,” Malone said.

Major concerns have been raised about the impact of the bailout on the federal deficit. During the recent Presidential debates, both candidates were asked what programs in their platform they would sacrifice because of the economic problems.

“Neither candidate came close to answering what they would sacrifice to get the economy back on track,” Malone said. “These are tough choices because you can’t do everything at once. Getting the economy straightened out, solving the problems, is paramount.”

One suggestion for boosting revenues is increasing corporate taxes. Malone said that would be a “horrific mistake.” Corporations don’t need to be punished when earnings and profitability are down because consumption is down. Higher corporate taxes could drive people away from the stock market even more, and the stock market is where many firms raise capital.

“The worst thing to do would be to raise corporate taxes,” Malone said. “I disagree with the Democratic Party on that. If they choose Paul Volcker and Warren Buffet as financial advisors, they would counsel against that.”

Malone doesn’t think banks hoarding the bailout money will be a problem. Banks may be playing it a little on the safe side because they don’t know what to expect. But just hoarding the money means the banks won’t profit by loaning the money out.

Banks may be temporarily hoarding the money in order to survive, said Dr. Pete Walley, director of long-range planning for the Institutions of Higher Learning in Mississippi.

Rebuilding trust

doubt part of the problem is that the underlying trust between lenders and borrowers has been shaken to such an extent that the easy thing to do is to not lend to anyone,” Walley said. “The trust factor will take time to rebuild. A side consequence is that individuals and businesses that need loans will not get them either, or they will be required to meet higher lending standards such that the net effect is fewer loans will be made.”

The U.S. may only be starting to see the worst of the economic decline. Walley points to a recent statement by the deputy governor of the Bank of England, Charles Bean: “The economic slump is still in its early stages, he said, as a result of possibly the largest financial crisis of its kind in human history”.

“Even if this is only half true, the crisis will not end soon nor recover quickly,” Walley said.

Nigel Gault, chief U.S. economist for Global Insight, the econometric model company Mississippi uses to forecast its economic activities, spoke at the Mississippi Economic Outlook Conference recently. In his presentation, he said that the worst is yet to come for the economy. His forecast for the U.S. used a baseline and a pessimistic forecast. He predicts that annual gross domestic product could decline to between 1.8% to 3.9% for the last quarter of 2008, gradually increasing back to zero growth between the first quarter 2009 and the third quarter 2009, then return to a more normal growth of 2% or so.

“Declines in GDP mean declines in employment, individual and government spending and industrial output,” Walley said.

In regard to the cost of the bailout and impacts on the deficit, some experts believe that now is no time to be quibbling over deficit spending. For example, Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a bipartisan Washington group that normally pushes the opposite message said, “Right now would not be the time to balance the budget.”

“If it takes significant deficit spending to survive, the economy will have opportunities later to reduce deficits and undo the public intrusions into the private sector such as eliminating public ownership of private financial institutions,” Walley said. “I personally believe that we taxpayers will not recover the monies spent to keep the financial institutions solvent.”

He also believes that the increasing rate of deficit spending is unsustainable. For example, since 2000 the deficit has ballooned from $5 trillion to more than $10 trillion. That is double in eight years, or approximately a 9% annual growth.

There are some predictions that the 2009 deficit will be close to $17 trillion.

“I personally do not see how the rest of the world would allow the U.S. to continue to increase its deficit without some drastic action on their parts,” Walley said. “For example, the lenders of the world would demand much higher interest rates from the U.S. if we were to borrow those amounts from them. Also, there are articles appearing in non-US newspapers calling for some ‘basket of currencies’ to replace the U.S. dollar as the world trading currency. How much paper money can the U.S. print without creating any underlying value? I do not see how the deficit can increase much more without serious impacts on our way of life.”

Long time coming?

As to the perilous path of the economy, Walley thinks this crisis has been in the making for many years. He recently re-read the national bestseller by Larry Burkett, “The Coming Economic Earthquake” that he wrote in 1991 and revised in 1994.

“Burkett was writing 17 years ago about issues that he observed prior to that so, yes, the events leading up to this crisis have been in the making for many years,” Walley said. “Most will argue about the causes of the current crisis, but the roots of it lie in decisions made some time ago.

“As to what to do, I do believe in the ‘market’, that is, the collective actions of the many persons and institutions involved in the economy. So, let the market work as much as possible. While I admit that the market works, the downside is that the market never cares about an individual or a geographic boundary like the State of Mississippi. If it be the case that the market is indiscriminate, then individuals and the state should be more prepared to weather the crisis. The public must have a greater understanding about what is happening in order to make personal choices on how to react. And the state should begin to prepare for downturns in the economy by being ready to help people through the crisis.”

Walley does not see any easy or quick ways out of the current crisis; the workout will be slow and painful.

“Let us hope that the downward push by the interaction of the economy and the credit markets begins to level out,” he said.

Contact MBJ contributing writer Becky Gillette at 4becky@cox.net.


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