Page last updated at 21:09 GMT, Tuesday, 25 November 2008

Costly plan creates debt mountain

By Greg Wood
North America business correspondent, New York

Henry Paulson, 25 Nov
Mr Paulson hopes the stimulus package will make more lending available

"Millions of Americans cannot find affordable financing for their basic credit needs."

Those words, from Treasury Secretary Henry Paulson, sum up the biggest problem facing the US economy.

The new $800bn (526.8bn) bailout from the Federal Reserve is designed to fix it.

The Fed is going to spend $600bn buying up mortgage-backed securities, home loans which were bundled up and sold as investments.

These toxic assets are virtually worthless and nobody else wants to buy them.

But if the Fed steps in then - the theory goes - the financial companies which hold these assets can use the money they receive to fund new mortgages at lower rates.

The same theory applies to the $200bn which the Fed is lending to holders of other investments backed by car loans, student loans and credit cards.

Tax cuts

If credit starts to flow again, then consumers will spend more. At the moment they are doing the opposite.

Dollar notes
Disposable income is falling at its fastest rate in six decades

Consumers slashed their spending by 3.7% between July and September, as fear of unemployment grew. Disposable income is falling at its fastest rate since 1947.

President-elect Barack Obama is working on an economic recovery plan which would deliver tax cuts to the middle classes and increase spending on infrastructure projects, such as roads and bridges.

But he has warned that cuts will have to be made elsewhere to pay for it.

He said his team would go through the Federal budget "page by page and line by line" to eliminate wasteful spending. And he highlighted agricultural subsidies as one area where savings could be made.

Mountain of debt

Even with savings, it is estimated that Mr Obama's stimulus plan could cost an extra $700bn.

The US budget deficit hit a record $455bn in the year to the end of September. Some forecasters believe it could hit $1 trillion in the current financial year.

The Federal Reserve's new bail-out plan will also stretch its resources, ample though they are.

It may have to sell Treasury bonds and bills which it owns to meet the cost of buying up mortgage-backed securities. It may even have to print money.

The US authorities are building up a mountain of debt for the future. But they are willing to take that risk to rescue the country from its present economic and financial crisis.

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