Rewriting the Global Playbook

October 31, 2008 07:00 PM

Dealing with the spreading financial crisis has become like a high-stakes game of Whac-A-Mole as policymakers bat down one crisis only to have one after another pop up. And policymakers have been using mallets they haven't touched in decades.

The U.S.'s financial foundation has clearly been shaken—and the erosion has gone global with several countries' financial situation teetering on the edge of collapse. Conventional wisdom says it may well get worse before it gets better.

Test of "too big to fail.” As the government helped facilitate the sale of Bear Stearns to JPMorgan Chase earlier this year, most assumed that it was because allowing Bear Stearns to go under would create market havoc. That same thought process accompanied the government action on Fannie Mae and Freddie Mac, backers of a huge amount of U.S. home mortgages.

Despite that government action, about 25% of U.S. banks figure they will lose an estimated $10 billion to $15 billion from the federal takeover of Fannie Mae and Freddie Mac, according to the Wall Street Journal.

Then, the Federal Reserve gave its blessing to convert investment banks Morgan Stanley and Goldman Sachs Group Inc. into traditional bank holding companies. While this may trim their profit potential, it also reduces the level of downside risk that both firms face.

But while those two companies successfully made the shift, venerable Lehman Brothers was allowed to go under as government officials like Treasury Secretary Henry Paulson rejected a takeover. That line of thinking prevailed until insurer AIG was given an $85 billion infusion and the government took a stake in the firm in exchange. It fit the "too big to fail” template after regulators determined what it insured had tentacles deep in the U.S. and world financial arena.

As the financial meltdown continued, Paulson pushed for a $700 billion rescue plan that would establish a government entity to buy up these bad assets held by companies, with the goal of reselling them back into the market. Lawmakers grilled Paulson and Fed Chairman Ben Bernanke on whether the plan would work and fretted about the U.S. taxpayer being asked to shoulder the cost of the plan. Paulson chillingly warned that taxpayers are "already on the hook.”

Initially, the House rejected the bailout package. Shortly after, the Dow Jones Industrial Average plummeted 777.68 points, or 7%, to 10,365.45—the biggest one-day point drop and biggest percentage decline since trading resumed after the terror attacks in 2001.

That sobering market vote led lawmakers and policymakers back to the table. By the time a Senate vote rolled around on Oct. 1, the plan had swelled in terms of provisions added to garner support. It worked. The Senate cleared the modified plan 74 to 25, followed by House approval Oct. 3 on a wide 263 to 171 margin.

But that's when things took a global turn. Stock markets around the world fell as fears rose that the U.S. plan might not work and wouldn't address the growing crisis in other countries.

Country after country mulled over what to do, with some opting to buy up banks to shore up confidence. Then, six central banks—the U.S. Fed, the Bank of Canada, the Bank of England, the European Central Bank, Sveriges Riksbank, and the Swiss National Bank—teamed up to reduce short-term interest rates. In addition, the Fed waded into the commercial paper market, effectively loaning directly to companies—something not done since the Great Depression.

Most of U.S. agriculture is solid and strong, and is poised to escape the brunt of this situation. That wasn't the case for Farmer Mac, which held investments in Lehman Brothers that turned sour. This weakened its position and prompted the Farm Credit System to inject capital into Farmer Mac.

Many farmers (and bankers) painfully remember the 1980s and have taken steps to help weather this storm.

Some ag-related banks have taken steps like limiting the loan-to-value ratio on property purchases to around 65%. They reason the borrower can withstand a 30% drop in land values and still have a loan that will "work.”

U.S. agriculture's balance sheet looks much better than it did in the 1980s. The average debt-to-equity ratio is expected to fall from 10.6% in 2007 to 9.9% in 2008, and the debt-to-asset ratio to fall from 9.6% to 9.0%.

Can U.S. agriculture still get caught in the crisis? Yes. Especially if tightening credit spills into ag lending.

"We could see tight credit markets having an effect on agricultural production,” warns USDA Secretary Ed Schafer. "It's something we're watching.”

With commodity prices under pressure, vigilance is key to ensure that ag doesn't become one of the "moles” to pop up for financial policymakers.

Rescue Plan Details
The core of the bailout plan remains virtually unchanged since Treasury Secretary Henry Paulson presented it to lawmakers in September. It authorizes the Treasury to buy up to $700 billion in troubled assets of financial institutions. The funding is provided in installments, making $250 billion available immediately and $100 billion upon the President's certification. A final installment of $350 billion would be available pending a congressional vote.
Key Plan Additions
¡FDIC insurance: Through 2009, Federal Deposit Insurance Corporation (FDIC) protection for bank accounts will be increased to $250,000 from $100,000 per account. The bill also would give the FDIC unlimited borrowing access to Treasury funds through 2009. The FDIC now has $45 billion in funds backing $4.5 trillion in deposits.

¡Executive compensation: When the Treasury Department buys more than $300 million in assets at auction from a single institution, executive compensation above $500,000 will not be tax-deductible and the institution will be subject to penalties for some golden parachute payments.

¡A stake in companies: The Treasury Department will receive warrants for nonvoting stock from participating financial institutions, if needed, to cover losses and administrative costs while allowing taxpayers to benefit from equity appreciation.

¡Farm equipment: Reduces to five years from seven years the period in which the cost of certain farm equipment can be recovered.

¡Disaster relief provisions: The measure contains several disaster relief provisions.

Tax Breaks and Offsets
The measure contains $150.6 billion in tax breaks and $43.5 billion in offsets that include:

¡Alternative energy: Extends and modifies the existing Section 45 credit for producing energy from certain alternative sources, including extending the credit through 2009 for wind and refined coal facilities and through 2010 for other sources, such as closed-loop biomass, open-loop biomass, geothermal, hydropower and trash combustion facilities.
¡Alternative fuel property: Extends for one year, through 2010, a 30% credit for alternative refueling properties, such as E-85 and natural gas pumps, while expanding the credit to cover electric vehicle recharging property. Maximum credit: $30,000.

¡Depreciation rule: Allows various types of cellulosic biofuels, and not only cellulosic ethanol, to qualify for a 50% depreciation rule.

¡Biodiesel and renewable diesel credits: Extends through 2009 the $1 per gallon credit for producing biodiesel, the $1 per gallon credit for producing diesel from biomass and the 10% credit for small biodiesel producers. Also eliminates requirements that renewable diesel be produced using a thermal depolymerization process and clarifies that credits are designed for fuels produced and used domestically.

You can e-mail Roger Bernard at

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