Plan B is now in the works, or is that Plan R?
On Wednesday, the U.S. Senate will consider its own version of a financial “rescue” package. The word "bailout" is apparently no longer the right term for these plans.
According to Associated Press reports, the Senate plan will include an increase in the cap on bank accounts insured by the federal government to $250,000 from $100,000. If enacted, this should give depositors more breathing room and provide bank managers greater sources of funds.
Meanwhile, financial market regulators are hard at work despite the political gridlock over the financial market crisis. The FDIC is continuing is assistance to good banks moving in on takeovers failing banks. Many bank stocks have held up well throughout the crisis. Look to a couple of good banks with large operations in Idaho for example -– US Bancorp and Wells Fargo. Both these companies have strong balance sheets and good cash flow.
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The Securities and Exchange Commission announced Tuesday it will ease some accounting rules, making it easier for banks to meet their capital requirements. The announcement came out as a "clarification" to rules for valuing loans on their books at the going market price. This so called mark-to-market, or fair value accounting procedure is receiving strong criticism but is unlikely to change how much lending banks can or will lend.
The lending gridlock is the root of our problems this week. The key bank-to-bank lending rate, the overnight London Interbank Offered Rate, or LIBOR, is high an and rising. The AP reports this is the highest level since the British Bankers Association began tracking that rate in 2001. Normally the LIBOR rate is just slightly above the Federal Reserve's target fed funds rates, but is now more than 4 percentage points above the target rate of 2 percent. The high bank lending rate will most certainly lead to higher lending rates for mortgages and other loans tied to LIBOR.
Higher interest rates always imply higher risks, or uncertainty. Whether or not loans on the books today are priced at the market, banks are unwilling to lend because of uncertainty about the future. To better judge a banks condition to weather the storm regulators and investors alike should look to the cash flow generated by a bank’s on going loan portfolio. A suspension of fair value accounting rules is not the answer.
Despite all the financial upheaval, diversification continues to work well for investors. The stock and bond markets are once again moving in opposite directions, lowering the volatility of a well balanced portfolio. Over the past year, the S&P 500 is down 25 percent while the U.S. Treasury investment is up 10 percent. The average Balanced Mutual fund has lost only half that of the average stock mutual fund.
Financial markets remain one of the most regulated industries, and this system is hard at work this week. While the various government entities discuss the situation and act under their existing authority investors will do well to maintain a diversified portfolio of stocks and bonds.
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.