Financial institutions should benefit in the form of increased investor and counterparty confidence that a clear risk facing financial institutions can be resolved with defined parameters of ultimate loss. While Fitch does not envision immediate rating changes for U.S. financial institutions in response to the announcements today, the continued progress on this front is viewed as a positive development.
In addition to the use of TARP funds to inject capital, the program will entail additional contingent liabilities for the U.S. government in the form of FDIC guarantees on debt issued to finance asset purchases and a further expansion in the Fed's balance sheet to provide additional leverage. The maximum scale of the scheme is indicated at USD1trillion, equivalent to 7% of 2008 GDP, but the net cost to the government will be lower than this. The public private partnership construct of the plan should help provide a framework where reasonable price transparency can be achieved.
The prospect of the government providing some risk protection to shield investors and the financial institutions from future price volatility helps define parameters of ultimate exposure. If executed properly, this plan can be instrumental to resolving one of the sizable risk issues that banks have faced since the onset of the current crisis. If successful, the plan should allow banks to achieve improved access to funding sources and incremental capital to help address the additional risks they are facing in the current operating environment.
U.S. public finances are deteriorating as a result of a deep economic recession and large-scale fiscal policy easing. Fitch expects general government gross debt to rise to over 80% of GDP by the end of 2010 - up from an estimated 62.3% at end 2008 - by which time it is expected to be the highest among 'AAA' sovereigns. However as Fitch noted in a recent research report ('High Grade Sovereigns and the Global Financial Crisis'), high grade sovereigns can absorb and respond to the current extreme shock and still maintain very strong credit quality over the medium to long-term.
Large 'AAA' sovereigns like the US have an exceptionally high degree of fiscal financing and balance sheet flexibility, which provides headroom to enact measures to counter the impact of the global financial crisis and recession and to protect their economies and hence the tax base over the medium term. The US government's status as the global benchmark sovereign borrower and the US dollar's dominant position as a global reserve currency enhance this financing flexibility even relative to other large 'AAA' sovereigns. This gives the government time to embark on gradual fiscal consolidation over the medium term to stabilise and reduce public debt levels.
