Published October 4, 2008

Smells like recession

US lawmakers okay US$700b rescue plan but credit crunch knocks out economy

By CONRAD TAN
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(Singapore)

THE bailout package has a nice ring to it, but economists now say that it is nowhere near enough to get the global or even the US economy out of jail.

The massive US$700 billion rescue plan aimed at saving the US financial sector returned yesterday before the House of Representatives with fresh sweeteners to sway them. It worked.

Having thrown out the plan last week and stunned stock markets across the world, the lawmakers voted yes in its latest incarnation by a margin of 263-171.

The Senate had already approved the plan earlier this week. So what happens next?

Quite simply, more trouble, economists say - with a US recession now increasingly likely. This was the case even before the rescue plan was approved. Crucial credit channels remain jammed, as banks everywhere grow increasingly nervous about lending to one another, choking the supply of credit to fund business operations and investment activity. 'Whatever happens over the weekend, the outlook for the global economy is much dimmer,' said Song Seng Wun, senior economist and head of research at CIMB here.

He warned that Singapore's economy could stall or even contract in 2009, if the US slips into recession next year - a scenario 'which now looks increasingly likely'.

'The drag will be from lower exports as well as a significant slowdown through the economy, with perhaps the only exception being the construction sector,' he added.

In a startling sign of how deeply the crunch was biting, nearly 100 US corporate treasurers took part in an emergency conference call on Thursday to warn one another that banks there are using any excuse to charge more to renew lines of credit, Bloomberg reported. Banks are afraid to lend even to investment grade corporate clients, who are struggling to keep credit lines open to pay employees and purchase raw materials. Some were charged an extra 75 basis points to keep credit lines open.

Meanwhile, the authorities are turning to every weapon in their arsenal - and finding it ineffective. This week, futures traders were betting heavily that the US Federal Reserve would slash its target for the federal funds rate - the rate which US banks charge one another for loans - by half a percentage point to just 1.5 per cent at its next policy meeting on Oct 29, in a bid to stimulate economic activity by reducing the cost of borrowing.

But with interbank rates already more than double the Fed's official target rate of 2 per cent now, any cut in interest rates would be 'more of a psychological move to boost confidence that things are being done', said Mr Song. 'Banks will still be fairly cautious about interbank lending and counterparty risk' as a lot more US banks are likely to fail due to worsening economic conditions, he added.

Meanwhile, the real economy is being hit. Latest data showed that US employers slashed payrolls by 159,000 in September, the most in more than five years, a worrisome sign that the economy is hurtling toward a deep recession. Almost 760,000 jobs have disappeared this year. At a household level, that means millions of Americans will be forced to buy less 'stuff' - bad news for an economy that relies on consumer spending for about 70 per cent of its growth. Goldman Sachs economists expect a recession worse than the ones seen in 1990 and 2001.

Treasury Secretary Hank Paulson and Fed chairman Ben Bernanke have resorted to increasingly bold and desperate measures to fight the flames. They saved mortgage finance giants Fannie Mae and Freddie Mac and insurer American International Group, and arranged rescues for Merrill Lynch, Morgan Stanley and Goldman Sachs. They guaranteed money-market funds, banned short-selling of stocks; and pumped hundreds of billions of dollars into interbank markets worldwide to bring down borrowing costs.

None of it was enough to stop the crisis of confidence sweeping through the financial sector, which has already reached European shores. Governments in Europe are desperately trying to prop up more banks crippled by a lack of short-term funding.

London interbank offered rates or Libor, the global benchmark used to price a wide variety of bank loans and debt securities worldwide, remain far above official central bank target rates for interbank lending - suggesting that the deep mistrust between financial institutions is unlikely to vanish soon.

The Singapore interbank offered rate or Sibor for three-month Sing-dollar loans - an important benchmark for housing and business loans here - remains much higher than in early September, before Lehman collapsed. This, despite coming down of late. 'The bailout programme notwithstanding, things still could get worse,' said David Cohen, director of Asian economic forecasting at Action Economics in Singapore. He expects fewer new jobs to be created here in the coming months compared to the strong employment growth earlier this year, which will mean less spending by consumers and leaner times for businesses. 'Until the last couple of weeks, I was still optimistic that things could still get back on track. But now it does seem that the whole global economy is going to weaken going into 2009.'