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Tuesday, February 24, 2009

The Big If

Andrew Leonard reacts to Ben Bernanke's remarks on the economic outlook:

Ben Bernanke makes the case for strong government, by Andrew Leonard: The headline for the Wall Street Journal News Alert Tuesday morning reads "Bernanke Says Recession Should End This Year."

But the text of the message, summarizing the news from the Federal Reserve Chairman's testimony before the Senate Banking, Housing, and Urban Affairs Committee Tuesday morning adds a big "if":

"2010 'will be a year of recovery,' if actions taken by the government lead to some stabilization in financial markets."

And the actual text of his prepared remarks reveals further qualification: (Italics mine.)

If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.

That's not just a big "if." That's a giant, honking, humongous, get-down-on-your-knees-and-pray-for-salvation "if." Ben Bernanke predicts that we can hope for an economic recovery next year, only if government action is effective -- and that includes, in his view, Treasury Secretary Tim Geithner's plan to bring stability to the banking system, the details of which are still unknown. ...

So let's retitle that WSJ News Alert: "Bernanke Warns That Without Aggressive FDR-Style Strong Government Action to Boost the Economy, We're Doomed."

The belief that policy will work is important too, and Andrew's comments reveal how much lack of faith there is right now that policymakers can do anything to turn things around. We've gone from giving policymakers - the Fed in particular - credit for helping to bring about the Great Moderation to wondering if they can moderate anything at all. I still believe policy can help, but given how this has been handled to date, the general loss of faith is easy to understand.

Update: This doesn't do much for confidence:

Mysterious plans, by Paul Krugman: I’m trying to be sympathetic to the various plans, or rumors of plans, for bank aid; but I keep not being able to understand either what the plans are, or why they’re supposed to work. And I don’t think it’s me.

So the latest is that we’re going to convert preferred stock held by the government to common stock, maybe. James Kwak has a good explanation of what that’s all about. And it’s not at all clear what is accomplished thereby.

Here’s my stylized picture of the situation:


At the top are a bank’s assets. Below are its obligations to various parties, with decreasing seniority from left to right. I’ve drawn it to embody a pessimistic assumption about the bank’s finances, because those are the cases we’re interested in: the bank’s assets aren’t enough to cover its debts. Nonetheless, the stock, both preferred and common, has a positive market value. Why? Because of the Geithner put: the bank is protected from collapse, keeping the creditors appeased, but stockholders will get the gains if somehow things turn up.

What we want to do is clean up the bank’s balance sheet, so that it no longer has to be a ward of the state. When the FDIC confronts a bank like this, it seizes the thing, cleans out the stockholders, pays off some of the debt, and reprivatizes.

What Treasury now seems to be proposing is converting some of the green equity to blue equity — converting preferred to common. It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?

I just don’t get it. And my sinking feeling that the administration plan is to rearrange the deck chairs and hope the iceberg melts just keeps getting stronger.

Update: See Jim Hamilton's "That's not just a big 'if,' That's a giant, honking, humongous, get-down-on-your-knees-and-pray-for-salvation 'if.'"

    Posted by on Tuesday, February 24, 2009 at 10:08 AM in Economics, Fiscal Policy, Monetary Policy | Permalink  TrackBack (0)  Comments (35)


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