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Tuesday, 30 October 2012

Isn’t it too late to concern about the financial stability of the US banks?

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2013 is going to be a challenging year for the global economy. Set US obligations to reduce the growth of budget deficit during 2013 and 2021 years and termination of the reduced taxes from 2013 may weaken consumption and cause double dip recession in the US with the contingency effect on global economy. Moreover, isn’t it too late to concern about the financial stability of the US banks due to approaching fiscal cliff?

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 which was passed by the US Congress and signed by President Barack Obama on December in 2010 terminates a two year extension of reduced income taxes known as the “Bush tax cut” in 2013. It also terminates extension of several other measures such as unemployment benefits and reduction of social security and medical care taxes. Moreover, according to the approved Budget Control Act of 2011, US was able to increase debt ceiling to $16.4 trillion in exchange for mandatory $1.2 trillion cuts of budget expenditures during the period from 2013 till 2021.

According to the analysis of the Congressional Budget Office – Fiscal Tightening in 2013 and Its Economic Consequences, published on August 22, 2012, a sharp reduction in the federal budget deficit will cause economy to contract but also put federal debt on more sustainable way. If current laws remain unchanged those lead to the tax increase and spending cuts the federal budget deficit will be reduced by $487 billion in 2013 and federal budget deficit will be $ 641 billion in 2013. According to this scenario it is expected that economic growth will contract to -0.5 % in the 4^th quarter of 2013 compared to the 4^th quarter of 2012. In case the lawmakers extend most tax cuts and other forms of tax relief and prevent automatic certain spending reductions, the federal budget deficit may be reduced by $91 billion in 2013 and federal budget deficit is projected to be $1,037 billion in 2013. According to the alternative fiscal scenario, it is expected the economy to growth by 1.7% in the 4^th quarter of 2013 compared to the 4^th quarter of 2012.

 

It is likely that in the anticipation of the worst case scenario and sharp economic contraction in 2013, the Federal Open Market Committee (FOMC) of the US Federal Reserve decided to continue monetary stimulus with third round of large-scale asset purchases. According to the statement of the FOMC meeting released in September 13, 2012 the Committee agreed to purchase additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also decided to continue through the end of the year its programme to extend the average maturity of its holdings of securities and to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. It was expected to increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year and put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The continued monetary stimulus programme lifted equity markets; however, will capital gains from the equity price increase be substantial to meet investors’ in the US markets expectations related to the increased taxes on capital gains in 2013. Additionally, will the future economic environment promise more business growth opportunities and policies of higher dividends, so that gains from the dividends were substantial to meet investors’ expectations including increased taxes on dividends in 2013? Moreover, the fiscal policy of higher taxes create more incentives for corporations to fund development through borrowing due to tax shield which leads to more lending opportunities for banks and increased financial risks related to higher leverage of corporations.