Help is on the Way for the Credit Market…Or is it?

The $700 billion financial rescue package provided by the government produced action from other institutions also trying to help the economy. This time it comes free of charge …

The $700 billion financial rescue package provided by the government produced action from other institutions also trying to help the economy. This time it comes free of charge to taxpayers.

The Federal Deposit Insurance Corporation was created in 1933 to restore consumer confidence in the US banking system. In June, 2008, there were 8,451 banks insured by the FDIC. One of the main purposes of the FDIC is to assure the general public of its member banks’ stability.

The FDIC operates on capital obtained not through taxes, but rather banks that are paying members. The FDIC is again looking to raise consumer confidence in the national banking system. This go-around requires upping the ante—from $100,000 to $250,000 worth of insurance on interest bearing accounts. Noninterest-bearing accounts receive unlimited coverage.

Continuing its efforts, the FDIC is busy enacting the Temporary Liquidity Guarantee Program (TLGP) in hopes of boosting the sluggish credit market.

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How the TLGP works

By offering additional capital to banks for a small fee (50 to 100 basis points—the equivalent to ½ to one percent—depending on the length of the loan), the FDIC aims to help banks lend with confidence again. The majority of loan recipients are intended to be Wall Street and Main Street businesses plus home mortgage applicants.

Participating banks that loan money after October 14, 2008 qualify for the extended insurance for a small fee as long as the loan terms are for at least 30 days. Under this program, banks can go to the FDIC to collect if the borrower misses just one payment.

"We are confident that the changes our board approved today will create significant investor demand, and dramatically reduce funding costs for eligible banks and bank holding companies," said FDIC Chairman Sheila C. Bair. "I expect that the industry will take full advantage of this guarantee. I’m confident that the program, working in complement with the Treasury’s Troubled Assets Relief Program and the Federal Reserve’s Commercial Paper Funding Facility, will achieve its intended purpose to help insured banks increase lending in a responsible way to consumers and businesses."

The TLGP is currently scheduled to run through December 2009 for loans that are issued on or before June 30, 2009.

What does the TLGP mean for the borrower?

As with price increases in nearly every industry, the consumer usually pays for it. If a bank pays more for insurance, interest rates will likely increase at least slightly. The Federal Reserve effectively sets the prime interest rate, and it seems likely the prime will decline in hopes that a wave of home purchases will stabilize the market and help turn the economy around. The plan to lower rates, presented by the National Association of Realtors, is not completely worked out or accepted by the Federal Reserve, but could be a beginning of a solution. The last large drop to the prime, a half a percent, resulted in a 37% rise is applications, according to the Mortgage Bankers Association.

A drop in prime accompanied by increased insurance could mean tax payers won’t feel the increased rates that FDIC insured banks that are participating in the TLGP will pay for capital. On the other hand, skyrocketing unemployment rates and stringent lending standards could debunk all of the government’s efforts, including the FDIC’s. It’s going to be a difficult balance to strike in a short amount of time.

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