Get your boxing gloves on because the fight is ON! It is Main Street vs. Wall Street and in the latest round, Main Street has won. Despite the protests and tens of thousands of letters, emails and phone calls to their Senators, Main Street needs to realize that there are no winners if Wall Street fails. This is a slippery slope and if Wall Street loses its footing, everyone else could fall as well. This is not to say that I don’t agree that bankers need to be punished for their extravagant risk appetites, but it is time to start thinking about the consequences for the average American.
Overnight LIBOR rates, which is the rate at which banks lend to each other hit an all-time high of 6.88 percent. This is 488bp higher than the 2% Fed funds rate. The 3 month LIBOR rate is also above 4 percent. Since many home equity loans, lines of credit, student loans, small business loans and credit card rates uses LIBOR as an index, the rise in borrowing costs will be felt on Main Street. The reason why the borrowing cost or LIBOR has surged is because banks are not willing to lend money. With the bailout plan in flux, cash is one of the most valuable commodities.
Here’s how Main Street will feel the pain if Wall Street doesn’t recover:
1. Evaporating Equity Market Wealth: $1 Trillion in market capitalization was wiped out from the stock market yesterday. For the average American who still has money in equities or has a 401k, the pain was certainly felt. Year to date, the Dow Jones Industrial Average is down 19 percent.
2. Higher Mortgage Rates: There aren’t that many mortgage lenders left in the market. Take a look at the rates that Wells Fargo is charging. On a 30 year fixed mortgage, they are charging 6% for conforming loans and a whopping 9% for jumbo loans. Home equity lines are being pulled by lenders left and right as they try to shore up their own balance sheets and reduce risks.
3. Larger Job Losses: In addition to all of the companies that have already gone belly up, we are in an environment where it is difficult for corporations on and off Wall Street to borrow or raise cash. As a result, they will start cutting back which means layoffs, hiring and project freezes. These ripples will be felt by Americans either in the form of a direct job loss, smaller raises and bonuses.
4. Lower Credit Card Limits: As if the problems in the labor market, higher mortgage rates and evaporating stock market wealth is not enough, the limits on credit cards are also being lowered. All of this translates into weaker consumer spending.
5. Weaker Housing Market: Housing market and stock market wealth are the single biggest assets for Americans. Tighter terms of credit, pulled home equity lines and a weaker economy will make it difficult for Americans to buy and sell homes. There is still a lot of inventory set to come onto the market over next 12 months. Here in NYC alone, construction projects are still underway. The problems on Wall Street means that the projects will either be frozen, prices will have to come down or inventory will end up sitting on the market for a longer period of time.
Main Street’s Biggest Argument
The biggest argument against the bailout is the cost to the US taxpayer who will end up shouldering the burden for years to come. This is a legitimate issue but unless Americans want to fall into a prolonged recession, Wall Street needs to be stabilized so that banks feel confident enough to stop sitting on their cash and start lending.
What About Invigorating Main Street Directly?
Directing more money into public works projects could certainly help Main Street by creating more jobs. Extending unemployment benefits will also make it easier for out of work Americans, but what Main Street really needs to realize is that the problem on Wall Street is confidence.
The compromise that is being floated around today is to reissue the bailout plan with higher FDIC insurance for all Americans. Lawmakers are proposing to hike the FDIC insurance from $100,000 to $250,000. Everyone wants some sort of deal to be done and this bribe to Main Street is brilliant because it offers them a jolt of confidence without having to realistically commit any additional money. Like health or life insurance, it is there for the peace of mind.
The 3 big banks that are left on Wall Street – Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup (C) will still be here when the dust settles. The following chart illustrates the distribution of deposits amongst the biggest commercial banks in American. According to the data, the Big 3 hold 75 percent of all US deposits and including Wells Fargo (WFC), that is close to 90 percent. So even if the 3 biggest commercial banks fail, the FDIC only has to fork up a limited amount of money.