US government unveils $800 billion second stimulus plan

Moving the bailout from Wall Street to Main Street, the US government announced yesterday that it would inject a whopping $800 billion (about Rs40 lakh crore) more into the economy to ease the mortgage and consumer credit market crisis and arrest the alarming downturn.

Coming after the bail-out of Citigroup with a $20 billion cash infusion and a $306 billion asset backing the previous day, the new economic package of $800 billion announced yesterday takes the US government's bailout bill so far to $1.5 trillion. It is likely to go up to $2 trillion with an expected announcement of $500 billion tax cut plan shortly.

The $800 billion economic package, announced jointly by the US Federal Reserve and the Treasury, changes track from corporate America to ordinary citizens and is aimed at unlocking the credit market and help homebuyers, small businesses and students to borrow.

The package is in two parts, one with a $600 billion programme to buy mortgage related debt and securities and the other $200 billion to buy consumer debt securities.

Under the term, asset-backed securities loan facility (TALF), the Federal Reserve Bank of New York will lend up to $200 billion on a non-recourse basis to financial institutions that hold securities backed by various types of consumer loans such as credit cards, auto and student loans.

Banks and other credit card and auto loan issuers prefer to bundle these loans into packages, selling parts of it to investors with different risk preferences. This allows the banks to offload a part of the default risk and make cash available for other activities.

"This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally," the Fed said in a statement

"This lack of affordable consumer credit undermines consumer spending and, as a result, weakens our economy," said Treasury secretary Henry Paulson at a press conference.

This will make money available more freely as demand for securities rise which in turn will ease the tight money market and also lower consumer borrowing interest rates.

According to the Treasury department, financing in new issuances was $240 billion last year but has fallen sharply this year due to the global economic crisis. As a result, major banks are now compelled to account for more of the loans in their balance sheets. But, with a shrinkage in the capital base, the banks refuse to lend.

The Treasury department will also give a $20 billion of credit protection to the Federal Reserve in connection with the facility, using its authorities in the 'emergency economic stabilisation act of 2008' and the Federal Reserve will buy up to $100 billion in direct obligations from mortgage giants Fannie Mae and Freddie Mac as well as the federal home loan banks.

The Fed also will buy $500 billion in mortgage-backed securities, pools of mortgages that are bundled together and sold to investors such as securities that have been backed by Fannie Mae and Freddie Mac.

The US Treasury will now have to ask the congress for the second $350 billion installment of the fund as it is running out of money to undertake other rescue acts as with yesterday's $20 billion commitment, $250 billion it pumped into the banks, $40 billion to AIG and $20 billion to Citigroup, it is now left with $20 billion out of the $350 billion.

President-elect Barack Obama's choice to replace Paulson with New York Fed President Timothy Geithner as the Treasury secretary, has played a central role in the $20 billion consumer lending programme.

Paulson said he is committed to a smooth transition with the new administration, saying it's "important that the next team understands everything we have in place."

Senator Charles Schumer said, "This new focus by Treasury and the Fed should help inject some much needed economic life into Main Street and couldn't come a day sooner."

Both Democratic and Republican lawmaker had earlier criticised the Bush administration of focusing too much on Wall Street problems and ignoring ordinary Americans.

The latest bailout package shows that the American economy is rapidly sinking as new data released on Monday shows that the US economy contracted in the July-September period by 0.5 per cent, and it was the worst since the world's largest economy shrank at a pace of 1.4 per cent in the third quarter of the recession period in 2001.

The Standard & Poor's/Case-Shiller national home price sales index dropped 16.6 per cent in the third quarter and the commerce department said the GDP shrank 0.5 per cent from July through September, revising down its initial 0.3 per cent shrinkage estimate.

Consumer spending which accounts for two thirds of US economic movement fell by 3.7 per cent in the third quarter 0.6 per cent higher then previously estimated.