WASHINGTON — The Bush administration moved Tuesday to bolster confidence in U.S. financial markets, calling for a temporary rise in insurance on deposits in the nation's banks and relaxing a complicated accounting rule that banks insist has been a big part of their problems.
These changes were rumored throughout the day, contributing to a rally on Wall Street that was also based partly on rising hope that Congress will try again later this week to pass a financial-system bailout. The rule changes were confirmed near the 4 p.m. close of trading on the New York Stock Exchange, sending share prices soaring and helping to gain back much of Monday's 777-point freefall.
The Dow Jones Industrial Average closed up 485.21 points to 10850.66. The S&P 500 rose 58.35 to 1164.74 and the Nasdaq ended up 98.60 to 2082.33.
The biggest potential change for consumers came from a statement by Federal Deposit Insurance Corp. Chairman Sheila Bair, supporting calls from both major presidential candidates to raise the limit temporarily on how much of a depositor's cash is subject to federal insurance.
Right now, deposits are insured up to $100,000 per account holder, regardless of how many accounts they hold in a given bank. Democrat Barack Obama and Republican John McCain both called for raising that threshold to $250,000 earlier Tuesday as a way to help calm fear of a financial meltdown.
"Unfortunately, there is an increasing crisis of confidence that is feeding unnecessary fear in the marketplace. To address this crisis of confidence, I do believe that it would be helpful for the FDIC to have the temporary ability to raise deposit insurance limits," Bair said in a statement, declining to target an exact figure. "This would provide the dual benefits of providing additional liquidity to banks for lending as well as provide some additional reassurance to depositors above the current limits."
Liquidity is a technical term for available cash on hand, and Bair believes the higher insurance caps will keep frightened depositors from withdrawing money. With more deposits, banks will be better able to deal with rising defaults on loans.
Congress must pass legislation before the FDIC can raise its bank account insurance amount.
There have been anecdotal reports of depositors moving funds from smaller or troubled banks to larger national lenders, but there's been no widespread run on banks. Bair's proposal seeks to keep it that way.
The downside from temporarily raising insurance caps is that the cost of the additional coverage would be paid by industry, which often passes rising costs to consumers through user fees.
Stock prices also rose on confirmation by the Securities and Exchange Commission that later this week it is reviewing complex accounting rules that require banks to estimate the current value of toxic mortgage bonds that have been eroding their balance sheets.
The SEC issued guidance late Tuesday on how banks should interpret existing rules, suggesting they have more flexibility than they've used.
The SEC is under pressure to relax how banks report the mortgage bonds' value. Their hold-to-maturity value gets lost when banks must try to determine their fair-market value right now, when no one wants to buy them.
Banks and some Republicans have called for this accounting rule change to ease pressure on banks to hoard their capital instead of lending it out. But consumer advocates warn that it would ignore the fact that an inability to assess the bonds' value is at the heart of the U.S. housing-finance crisis.
"You don't suspend the very rules to keep the players honest at a time when they are most likely to provide misleading information," said Barbara Roper, director of investor protection for the Consumer Federation of America, a consumer-rights group. "Allowing companies to lie to themselves and investors is not the solution to the problem, it is the problem."
Also boosting the mood on Wall Street was a pledge by President Bush — made before markets opened — to prod Congress anew to pass a rescue bill to get bad assets off the balance sheets of troubled banks. Some 133 Republicans and 95 Democrats in the House of Representatives rejected Bush's plan on Monday.
"For the financial security of every American, Congress must act," Bush said.
Meanwhile problems in credit markets actually grew worse on Tuesday.
The rate for overnight lending between banks spiked to 7 percent briefly Tuesday before recovering to a still-high 3 percent. That means banks are hoarding cash instead of lending it, and fear persists in credit markets.
In addition, corporations that raise money through issuance of short-term notes, which resemble IOUs, are paying increasingly higher rates to borrow. These short-term debt instruments are now as much as 4 percentage points above the Federal Reserve's target rate of 2 percent for overnight lending between banks.
As corporate America pays more to borrow the cash flow it uses to purchase inventory and make payroll, other spending falls. Often that translates into big layoffs on Main Street.
Another red flag in credit markets — one relevant for U.S. auto sales — is the staggering rise in the London Interbank Offered Rate. This rate, commonly called Libor, reflects the average of interest rates that international banks charge each other to borrow U.S. dollars in London. Interest rates on many U.S. student and business loans are pegged to Libor, which stood around 2.95 percent last week but soared to 6.88 percent on Monday and held there Tuesday.
"When you are talking about millions and millions of dollars (that auto) dealers have on their lots, the (borrowing) costs have become astronomical," said Ray Ciccolo, president of Village Automotive Group in Boston, which operates seven dealerships.
When Ciccolo borrows from a bank to purchase autos that he'll sell to the public, he's charged a rate tied to Libor.
"Banks that usually finance cars are becoming so cautious and conservative," he said. "It's only a matter of time before it is going to manifest itself in lots of job losses, and you're going to see the unemployment rate go up appreciably."
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