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Thursday, February 05, 2009

Fed Watch: And Now We Know....

Tim Duy:

And Now We Know…., by Tim Duy: I have been holding off on commenting about the impending, revised financial stabilization plan, content to let those such as Yves Smith express their dismay at the evolving package. I have run the gamut from dismay to anger to my current emotion, supreme disappointment. There were really only two glimmers of hope that the US could avoid a Japan-like multi-year stagnation. One was the offsetting effect of a strong global economy. Of course, we all know how that story ended. Poorly. The other was my certainty that US policymakers like NEC head Lawrence Summers and Treasury Secretary Timothy Geithner had studied the Japanese crisis up and down and realized that you needed to meet a banking crisis head-on, not with halfway measures that left the system crippled.

But today, reading CNBC’s coverage of the plan, it becomes painfully clear that we are headed full speed on a policy bullet train designed to repeat Japan’s errors. From CNBC:

The plan will be "smaller" than originally expected, said the industry source, and centered around government guarantees and insurance of troubled assets, what's called a "ring fence" concept.

Will the ring fence concept work? Consider this paragraph later in the article:

The ring fence concept has already been used with Citigroup ... and Bank of America... It involves government guarantees and insurance provisions for groups of bad assets, but they remain on the balance sheet of the institution. The bad bank concept literally removes them.

Look, just look, at the stock prices, plumbing the depths. From Bloomberg:

Bank of America Corp., the nation’s largest bank, declined to its lowest level in New York trading since 1984 on concern regulators may seize the company after a $138 billion U.S. bailout package failed to halt the slide.

I have got to say, at least from someone on the outside looking in, the US government appears to be headed down a path already proven to be a failure. Is more of a failing policy smart policy? But it gets worse:

The latest round of discussions also appear to have addressed the most controversial aspect of the big bank concept: Pricing.

Under the emerging plan, the government will buy toxic assets below the banks "carrying value," which is basically market value, but not at fire sale levels, the source said.

That approach will likely placate both taxpayer and Congressional concerns about the government over-paying for the assets. But, the source noted, it could "trigger an accounting problem for the banks," presumably because the institutions will have to report a loss on the transactions.

The Obama administration is now working on ideas to address that, which might entail a temporary suspension of certain accounting rules.

Classic. Absolutely classic. Is this really addressing the problem of pricing? Are we not in the same boat of “if we pay too little, the bank is undercapitalized, but if we pay too much, the taxpayer holds the bag and therefore we need to nationalize”? Obviously we are in the same boat, because the new plan may cause an “accounting problem.” Like insolvency. That is, in fact, a problem, no argument from me. Apparently, though, the Administration’s solution is a suspension of accounting rules. Translation – we are going to try to hide the problem.

As if investors won’t see through that mirage because all of you traders are clearly slow witted. Again, Bank of America already plumbing the depths…

Why are we here? Why, months after TARP, are we still not willing to dig down in the balance sheets of troubled banks and disgorge the questionable assets once and for all? Why, with a new Administration, supposedly unfettered from the ideological positions of the last Administration? More from CNBC:

The latest developments come as Congressional support for the bad bank concept and additional financial support for the financial sector is fading.

In a news conference Wednesday afternoon, House Speaker Nancy Pelosi (D.-Calif.) said she was "not so sure" that another bailout request from the Obama administration is inevitable, reversing an a previously-held assumption.

Sen. Charles Schumer (D-NY), a senior member of the Senate Banking Committee, Tuesday joined the bad-bank skeptics, telling CNBC the approach would be "hugely expensive" and added he prefers government guarantees of such assets.

Congressional Democrats, led by House Financial Services Committee Chairman Barney Frank (D.-Mass.)  have shared with the new administration their anger and disappointment over former Treasury Secretary Henry Paulson’s administration of the TARP program, which was seen as too generous to and too lenient on Wall Street firms.

The financial crisis has been so mismanaged that the public will not support package with a high price tag, a price tag that could climb into the trillions. And there is no way to even bring the issue to the public unless taxpayers effectively buy troubled banks, which can only be justified after first wiping out shareholders and bondholders. Then the bad assets could be rooted out once and for all. But this Administration appears no more willing than the last to consider temporary nationalization. They either do not want to own banks (I don’t blame them), or they are in too deep with Wall Street interests to upend the status quo.

We used to wonder aloud at the intransigence of Japanese policymakers. How could they allow their banking system to deteriorate? Why not take decisive action? Now we know: Fettered to an adherence to the status quo and an aversion to the concept of nationalization, the political will to attack the problem head-on is overwhelmed by the enormity of the financial crisis.

On a final note, the Administration still appears to selling the package with this line:

Both approaches are meant to spur new lending by banks.

And more from Bloomberg:

Earlier today, Senate Banking Committee Chairman Christopher Dodd urged the Obama administration to redesign the financial-rescue program to ensure that banks receiving aid increase lending and restrict salaries.

In the current environment, I can only imagine this is a pipe dream. The survey of loan officers shows clearly that while standards are tightening, loan demand is dropping off. Moreover, as the recession deepens and job losses mount, credit quality is deteriorating and loan losses increasing. Balance sheets are only coming under more pressure from rising credit card delinquency and expected downgrades of CMBS. Administration officials may find this hard to believe, but you cannot fix the banking system by encouraging banks to make more bad loans. And the number of opportunities to make good loans is rapidly drying up. If we sell this to the public – again – as the fix that will increase lending, there will be either massive disappointment or an effort to obfuscate balance sheets (since we are apparently ready to suspend accounting rules anyway) so that it appears government funds are being used for new lending (as if money was not fungible).

Geithner is slated to announce the new plan next Monday, February 9. Perhaps the final plan will be bolder than early reports suggest. And I can always hope that I am dead wrong and the “ring fence” concept is a spectacular success. But at this point, I am not optimistic...the Japan scenario is looming larger in my mind every day.

    Posted by on Thursday, February 5, 2009 at 04:32 PM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (23)


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