With unemployment at 9.1 per cent and activists up in arms, Obama and Bernanke are galvanised.
THE drums have been beating on Wall Street all week. They belong to Operation Occupy Wall Street, organised by social activism group Adbusters, which has brought hundreds of protesters to New Yorks financial hub. The group does not just include your typical professional hipster protesters. Among the crowd are former white-collared mums and dads who are struggling to comprehend that they are now considered to have been unemployed long term (that is to say, they have been without a job for more than 26 weeks). They are laying the blame for the jobs crisis at the door of corporate America, which they feel is playing puppeteer to the President.
The protest is ill-timed, however, and perhaps misguided, coming in a week when President Barack Obama has been accused of engaging in class warfare for the plan that he laid out on Monday to tax the rich more. The President has been brushing up on his history and has decided to channel former president Bill Clinton, who faced the same accusation of engaging in class warfare in 1993. Instead of shying away from it, Clinton made it a centrepiece of his campaign and it struck a chord with voters. He followed through on his promise and created a new marginal rate that affected the top 1.8 per cent of income earners. Despite the Republican shrieking that it would cost millions of jobs, it is now viewed as one of the major reasons why the economy lifted during the Clinton years.
In laying out his plan to cut more than $US3 trillion in national debt over 10 years, Obama showed he had also learnt from recent history. He said that if Congress repeated the debacle witnessed during the raising of the debt ceiling then he would let all the tax cuts from 2001 and 2003 expire in 2012 and close other loopholes. He vowed to veto any bill that is sent to him that proposes cuts to Medicare without raising taxes on the super wealthy, including Wall Street. The President is making a significant shift to ensure he is not seen as a lame duck.
His $US3 trillion-plus plan includes $US447 million for his American Jobs Act unveiled two weeks ago. It promises to cut $US1.1 trillion from the drawdown of troops in Afghanistan and Iraq, $US320 billion from overpayments in the Medicare and Medicaid programs and $US33 billion in subsidies from farmers who are often paid for crops they no longer produce.
The headline measure in the package is the so-called Buffett Rule. Billionaire businessman Warren Buffett has provided Obama with some momentum by declaring that it is grossly unfair that his secretary pays a higher rate of tax than he does. Obamas plan is for those earning more than $US1 million a year to be unable to pay a lower tax rate than Americas middle class. Currently middle-class Americans pay between 23 and 33 per cent in income tax, while the very wealthy can pay as little as 15 per cent.
This is not class warfare. Its math, Obama said. It is wrong that in the United States of America, a teacher or a nurse or a construction worker who earns $US50,000 a year should pay higher tax rates than somebody pulling in $50 million.
While Obama made positive and more decisive steps towards stronger fiscal policy this week, the 10-member board of the Federal Reserve was tackling monetary policy. Chairman Ben Bernanke has also turned to history, and an idea by another Democrat hero, John F. Kennedy, to overcome an unemployment rate he said would only gradually decline without intervention.
In 1961, Kennedy convinced the central bank to sell short-term Treasuries and use the money to buy long-term bonds. It was called Operation Twist, its name taken from the popular Chubby Checker song and used to describe the flattening of the yield curve.
On Wednesday, Bernanke said the board had voted 7-3 in favour of twisting again. He said the Fed would buy $US400 billion of Treasury securities maturing between six and 30 years and sell an equal amount of securities with maturation dates of three years or less. What that will do is bring down longer-term interest rates in the hope of encouraging companies to build new factories, consumers to buy new washing machines, and home owners to refinance their mortgages. The economic thinking is that if yields are low, it will push investors into riskier investments such as stocks.
How effective it will be is being fiercely debated. Remember, three members of the usually united Fed voted against the policy action.
John Silvia, chief economist at Wells Fargo, Americas second-largest bank, says the problem with Operation Twist is that rates have been low for three years and that still isnt spurring people to buy. Companies wont hire unless demand is there. The Fed can lower the cost of credit, but it cant force companies to create jobs, he said.
Economists arent optimistic that the Feds move will make a dent in the 9.1 per cent unemployment rate. A Bloomberg survey of 42 economists found 61 per cent felt the plan would fail in creating jobs. About 15 per cent said it could actually be harmful to the nations recovery.
Operation Twist hasnt left Wall Streets retail banks dancing for joy either. Most are likely to see profits weakened as they earn less on loans and investments. That is against a backdrop of already low interest rates and little demand for loans.
Ratings agency Moodys also cut the debt ratings of Bank of America, Wells Fargo and Citigroup this week, highlighting its feeling that the relationship between the US government and the big end of town is far from being as cosy as Wall Street protesters proclaimed this week.
Moodys said it believed that the government is more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled.
Obama and Bernankes Back to the Future week provided the sort of boost in leadership that both required. A Clinton-style campaign could help galvanise support from Obamas home base. But the double-act around fiscal and monetary policy needs to continue. Bernanke must deploy a third round of qualitative easing if Operation Twist fails and there is no sign of job creation. Meanwhile, Obama should not miss the opportunity for significant tax reform to build on the measures already announced.
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Frequently Asked Questions about this Article…
What is Operation Twist and how could it affect long-term interest rates and investors?
Operation Twist is a Federal Reserve move to buy $US400 billion of Treasury securities maturing between 6 and 30 years and sell an equal amount of securities maturing three years or less. The aim is to bring down longer-term interest rates to encourage companies to invest, consumers to refinance mortgages and push investors into riskier assets such as stocks. The Fed board approved the policy 7-3, but economists remain divided on how effective it will be.
Will Operation Twist reduce unemployment and create jobs?
The policy is designed to lower long-term borrowing costs to spur investment and consumption, which could help job creation. However, the article highlights widespread skepticism: a Bloomberg survey of 42 economists found 61% thought the plan would fail to create jobs, and some economists (including Wells Fargo’s chief economist John Silvia) note the Fed can lower credit costs but can’t force companies to hire if demand is weak.
How might Operation Twist affect everyday savers, borrowers and bank profits?
Lower long-term rates can make mortgages and other long-term loans cheaper for borrowers and encourage refinancing. For savers, especially those relying on interest income, returns on deposits and short-term investments may remain low. The article also notes many retail banks are likely to see profits weakened because they will earn less on loans and investments in a low-rate environment.
What is the Buffett Rule in Obama’s tax plan and what does it mean for high earners?
The Buffett Rule in the plan would prevent people earning more than $US1 million a year from paying a lower tax rate than America’s middle class. The article notes middle-class Americans currently pay between 23% and 33% in income tax, while some very wealthy taxpayers can pay as little as 15%, and billionaire Warren Buffett publicly supported the fairness argument behind the rule.
What are the main components of President Obama’s $US3 trillion-plus fiscal plan mentioned in the article?
The plan includes $US447 million for the American Jobs Act, projected savings of $US1.1 trillion from the drawdown of troops in Afghanistan and Iraq, $US320 billion from overpayments in Medicare and Medicaid, and $US33 billion by cutting certain farm subsidies. It also contemplates letting some tax cuts from 2001 and 2003 expire in 2012 if Congress repeats past debt-ceiling disputes and vows to veto cuts to Medicare without taxing the very wealthy.
What did ratings agency Moody’s do to major U.S. banks and why should investors care?
Moody’s cut the debt ratings of Bank of America, Wells Fargo and Citigroup. The agency said the government is more likely now than during the financial crisis to allow a large bank to fail if it becomes financially troubled. For investors, rating cuts can signal higher perceived credit risk and may affect bank bond yields and investor sentiment toward bank stocks.
How did Occupy Wall Street and public protests influence the political and market backdrop described in the article?
Operation Occupy Wall Street, organised by Adbusters, brought hundreds of protesters to New York to protest corporate influence and high unemployment. The protests coincided with heated debate over Obama’s tax proposals (labelled by opponents as ‘class warfare’) and helped frame the week as one of heightened public scrutiny of fiscal and monetary leadership, which can feed into political risk and market perceptions.
If Operation Twist doesn’t work, could the Fed pursue more easing like QE3, and what would that mean for investors?
The article suggests that if Operation Twist fails to stimulate job creation, the Fed may need to consider a third round of quantitative easing (QE3). Additional easing would be another effort to stimulate the economy and could further lower interest rates and push investors toward riskier assets, but the article notes such steps are conditional and debated among policymakers and economists.
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