His comment “Remember that the IMF is the custodian of the official consensus on the
global macroeconomy and financial system”. If the IMF is that big/powerful/interconnected, why isn’t it considered “too big to fail” in Johnson’s argument to bust up the same?

Canada is similar in size to California. The disastrous California property tax policies and uncontrolled immigration have lead to inflated home prices and extreme bias toward leveraging up through residential real estate. The current California burst bubble will only lead to a new bubble with low mortgage rates and no correction to property taxes or immigration growth. Unfortunately, the US considers no other avenue other than to copy the California mystique (which by the way ended ten years ago.)

Finally, you should have added to your comment …”when ‘conservative’ politicians take power and cut taxes.”… WITHOUT correspondingly cutting spending, controlling costs and reducing debt. Minus these steps, you are only a half of a conservative and what “party” is that? Moderate, moderate liberal, liberal conservative? How about “out of power?”

O Reilly? Ad hominem attacks don’t make your arguments any better. Everyone else in the finance industry would love to keep the status quo. Sit out the crisis and continue like it was as soon as the situation improves and the tax payers have paid for all them bankster losses. Never kill the chicken with the golden eggs.

Johnson has absolutely no idea how the interactions between the banks and the regulators actually play out. He’s a career academic. (And chief economist at the IMF is an extremely academic position, not to mention that there were a total of zero emerging market financial crises during Johnson’s tenure at the IMF.) If this was a debate about Euler equations, then Johnson’s opinion would carry some weight. But it’s not. When it comes to financial markets, Johnson clearly has no idea what he’s talking about (did he just learn what CDS were last year or something?). And that’s why everyone else I know in finance thinks Johnson is a joke.

It takes a bunch of things for that to happen though. As best as I can tell the top 3 are:

1) You need moderately high taxes (empirically speaking lower taxes = more spending since there is no “cost”, politicians compete on who can give the most away)

2) You need a moderate liberal government to hold power for a long time. See point 1 and what has happened in Canada (and of course the US) when “conservative” politicians take power and cut taxes.

3) You need meaningful economic activity and a moderate amount of income inequity (too much and you get South America, too little and you get the USSR).

http://blogs.usask.ca/the_bolt/archive/2009/01/canada_debt_gdp_2009.html

dollars carry implicit insurance in that respect — the insurance is the competitive advantage.

of course that has a problem — because of this the currency gets overvalued, which creates a lot of distortions, which has the potential of causing the currency to become less valuable.

Why the *entire* loan portfolio? First, the FDIC would not need to go through the labor-intensive determination of going through a bank’s portfolio loan by loan to see which now-performing loan could become toxic. Second, under the watchful eye and heavy hand of bank regulators, equity investment in “virgin” ultra-clean new banks would be safe and suitable for the federal entitlement funds. Third, an ultra-clean bank with a tabula rasa portfolio means that it would have no excuse not to lend to creditworthy borrowers (Blanchard’s chart 12 on credit standards). Under the Fed’s 10% reserve ratio a $100 billion capitalization could have created $1 trillion in fresh lending capacity overnight! Fourth, bank profits from spread income due to the Fed’s near-zero QE interest environment and zero exposure to credit bubble-vintage legacy loans would have provided *lush* common stock dividends for the federal entitlement trust funds.

Thus just like killing two birds with one stone, for the same issuance of federal debt, President Obama could have recapitalized the banks and cured the $56 trillion fiscal exposure of the Social Security and Medicare funds. In fact, because it would avoid touching the third rail of committing political suicide by raising taxes and/or cutting benefits, Congress should have been more the eager to fund the trillions necessary to give the finance system a “fresh start” recapitalization.

Also note that a semi-permanent, passive, diffused ownership stake by the American people (including voting rights) solves the nationalization issue of corporate control, and the problem of exit policy (Blanchard’s chart 14).

Unfortunately the second suggestion of ultra-clean new banks is now foreclosed by Geithner’s stress test. However two things that could derail it are:
1) the horizon of the stress test was to the end of 2010 [1]. This means that it completely ignored the pay-option ARM default wave, which assuming a 12 month delay from rescheduled resets (whose negative amortization ceilings are now slowed by ultra-low interest rates) will not peak until summer 2012 [2] [3].
2) political outrage over the Private-Public Investment Partnership (PPIP) where the FDIC could be abused as a toxic waste dump to dispose of now performing (and thus high priced) but later to toxic pay-option ARMs and their RMBS and CMO derivatives [4 [5]. In fact maybe PPIP may not be needed since the 19 banks passed their stress tests relatively unscathed!

In closing, apologies to Simon and James for repeating my “pet policy” solution but I did so because it addresses all of Blanchard’s concerns. Nevertheless, the federal government’s common stock shares in say, CitiGroup and Bank of American can still be gifted to the American people and then contributed to the Social Security & Medicare trust funds on their behalf; and these federal entitlement trust funds can still invest in AAA-rated TALF asset-backed securities, which would have the salutary benefit of creating monster demand thereby restarting the ABS markets of the shadow banking system.

The missed opportunity though is that like killing two birds with one stone, the same issuance of now low-interest federal debt could have been used to fix the US financial system and the $56 trillion fiscal exposure of the US federal entitlement trust funds–thereby providing relief for the federal budget. Why so much silo thinking by Geithner, Summers & Co.? All this to save the unsecured creditors of troubled banks?

—————————————–
[1] See footnote 7 on page 8 of the Fed’s “Supervisory Capital Assessment Program: Overview of Results” (May 7, 2009). My guess is that the Fed DID NOT COUNT the 2011 and 2012 pay-option ARM resets in its stress tests. Like being in the eye of a hurricane, 2009 and early 2010 will be a quiescent period for residential real estate defaults.
[2] Gopalm, Prashant, “Good News: Option ARM Resets Delayed,” Business Week, April 16, 2009 (see chart for reset schedule).
[3] “A Second Mortgage Disaster On The Horizon? New Wave Of Mortgage Rate Adjustments Could Force More Homeowners To Default,” CBS 60 Minutes [video], December 14, 2008.
[4] Christie, Rebecca, “FDIC May Let Investors Buy Toxic Assets Without Treasury Stake,” Bloomberg, April 30, 2009.
[5] “The Greatest Boondoggle in History: Banks Buoyed at Taxpayers’ Expense,” Yahoo! Finance Tech Ticker [video], Posted May 08, 2009 (“While much of the focus is on the stress tests and banks’ efforts to raise cash, the real story is Geithner’s Public-Private Investment Program (PPIP), says William Black, an Associate Professor of Economics and Law at the University of Missouri-Kansas City. The PPIP is the “greatest boondoggle in the history of the world,” says Black, a former bank regulator who was counsel to the Federal Home Loan Bank Board during the S&L crisis. As occurred during the S&L era, Black says the PPIP will allow banks to exchange “trash for cash” and turn “real losses into faulty gains.” If the goal of Tim Geithner and other regulators was “to rip off the American taxpayer for the benefit of the least-deserving wealthiest people you can imagine, well–mission accomplished,” Black says.”)

My suggestion for “something” would be to first gift the federal government’s common shares (including voting rights) in the troubled banks to the American People, and then contribute them to the Social Security and Medicare trust funds on their behalf. Like David Swensen’s “equity-oriented” Yale Endowment Fund and taking advantage of what Albert Einstein called the more powerful force in the universe (compound interest), capital appreciation and common stock dividends over a 75-year horizon would go a long way towards curing the $56 trillion fiscal exposure of the federal entitlement trust funds.

Another suggestion to would be for the federal entitlement trust funds to invest in the AAA-rated, TALF asset-backed securities (which with leverage from the Fed could have returns of up to 20%). Wow! So not only would these ABSs throw off massive amounts of interest income to finance Social Security & Medicare disbursements, but their investment by the federal entitlement trust funds would create such a monster demand that it will certainly restart the ABS markets of the shadow banking system.