Bill Jamieson: Make or break? Global recovery hinges on US

THIS is a pivotal period for America – and for all of us. A year to the week that Bear Stearns went down in flames to kick off the great banking crash, the mighty US Federal Reserve joined the great global 'quantitative easing'– buying masses of US government bonds in the hope of driving down commercial interest rates and easing the ferocious downward spiral of the world's biggest economy.

A make or break moment? We are close to it, and the world is looking to America to show the first signs of recovery. The dramatic and unexpected move cheered the US stock market, but drove down the dollar against the yen and the euro.

Was this a smartly timed initiative to build on a fragile return of confidence in America's deeply troubled financial sector? Or a candid admission of defeat – that President Barack Obama's stimulus plan and previous government and central bank interventions were simply not working?

America is now at a critical inflection point. Banks are reporting that they traded profitably in the first two months of the year. Housing starts showed an unexpected pick-up last month, kindling hopes that the nightmare of plunging house prices, loan arrears and defaults may at last be easing.

But the economy overall is still reeling under savage blows. That is the backcloth to the swelling tide of criticism over the performance of new US Treasury secretary Tim Geithner. His eagerly awaited plan to buy toxic assets from the banks lacked the clarity and the detail necessary to convince jaded markets that this measure would really make a difference where others had stumbled or fizzled out.

Geithner is now struggling to gain credibility from this worst of starts. Obama came to his defence with a robust statement of support late last week. But that does not mean the US Congress will be any more disposed to agree to further bailout money for the banks. Obama included a $250bn (£173bn) financial sector bailout item in the budget he announced last month, implying that the administration will need up to $750bn more in troubled asset funds. Roger Altman, a former senior Treasury official in the Clinton administration, said: "I am quite certain that Tim Geithner has the full backing of the President and will continue to have it. The main question is can anybody, including President Obama himself, persuade Congress to give new money in this climate?"

This task has now been made much more difficult by the convulsion in American public mood over continuing evidence of arrogance and greed by those at the heart of the financial storm. In the home of free market capitalism, the public mood has swung viciously against any further support for the country's stricken financial institutions. This follows news of the proposed $165m of bonus payments for executives in the government-supported insurance giant AIG – it has received more than $170bn in public funds in the past four months.

Not only did the bonus payments draw astonishing criticism direct from the US President, but they also sparked huge anger in Congress, with moves to target such payments with a swingeing 90% tax. Dictators in the former communist East European bloc could only dream of such assaults at the very heart of Wall Street.

Obama has now charged Geithner to explore every avenue to claw the bonuses back. Federal Reserve chairman Ben Bernanke added to the furore last Friday, calling on banking supervisors to pay "close attention" to compensation practices as they examine the soundness of financial institutions.

The past few weeks have brought some sparks of hope that the intense ferocity of the downturn may be starting to ease. First Citigroup and then Bank of America announced that they had been trading profitably in the opening two months of the year. These were the first statements from American banks in 12 months that were not accompanied by massive write-offs, provisions, cost slashing and redundancies.

This has helped the banking sector, and Wall Street overall, to rally strongly from multi-year lows. Further help came last week from an unexpected rise in US house sales – a critical indicator of where the economy is heading.

Official figures showed new construction starts for US housing surged 22.2% in February, the first increase since last April. Investors and the wider public are now wary of reading too much into one month's set of figures and this is the second or third time that the housing market has been pronounced to be "on the turn". Nevertheless, Wall Street was cheered by the change in direction if nothing else.

But elsewhere the economy has continued to slump. The car industry is on its knees, with Chrysler and General Motors alone seeking a $22bn bailout. So far, $5bn has been forthcoming. Data from American Express and Citigroup showed US credit card defaults rising to 20-year highs, underscoring the fragility of the financial system. And construction equipment giant Caterpillar has announced 2,400 redundancies at five US plants. The company has already said it is cutting a total of 20,000 jobs worldwide, slashing executive pay by up to 50% and imposing a global hiring freeze.

For an economy supposed to be embarking on a massive wave of New Deal-style infrastructure projects to combat the downturn, this was not a reassuring sign.

So far, support for Obama is still running high. But another few weeks of bad news and America runs the risk of a Great Disillusion and retreat from the man who urged the audacity of hope. This would spark a calamitous slump in confidence and the onset of depression.

That was the background to the surprise announcement by the Fed last Wednesday that it would pump about $1 trillion into the economy, including the purchase of up to $300bn of long-term Treasury securities over the next six months.

The news sent both government bonds and stocks soaring as investors expected the move to drive down borrowing costs for everything from mortgages to credit cards. It is likely to produce an immediate drop in mortgage rates of 0.25 to 0.5 percentage points, as the Fed made clear that it would be able to purchase the majority of new mortgage-backed securities for at least the rest of the year, and possibly longer.

That's great news for those borrowers with good incomes and healthy credit scores who are able to qualify for a loan. But dramatically tighter lending standards have made it tough for many borrowers to qualify. Still, it was a plus for the housing industry. The Fed said it would build on a plan to buy mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac. The central bank will buy an additional $750bn, bringing its total purchases of these securities to $1.25 trillion. It also will boost its purchase of Fannie and Freddie debt to $200bn.

But while Wall Street received the news warmly, the dollar plunged against other major currencies as markets considered the long-term effects of the Federal Reserve's decision. The US currency dropped more than six cents against the euro, as economists fear the Fed's massive bond-buying programme could ignite inflation and weaken the dollar.

For the moment, the battle to secure an immediate turnaround in America's fortunes is intense. Public patience in a system famed for such turnarounds in the past is the thinnest it has ever been.