When’s the Make-Up Test? Tomorrow.

Saturday, October 11, 10pm.

The world’s finance ministers sat for several tests this weekend, and it’s not yet clear how they did.  If we set the bar low enough (i.e., no public criticism of each other), they did OK.  The Italian finance minister did threaten not to sign the communique on Friday afternoon, but this was not particularly meaningful (think about it: if Italy walked out of the G7, how would the markets view Italian risks on Monday morning?)  Everyone else was reasonably polite.

But if we were hoping for specific steps to be announced, then Friday’s list of principles from the G7, and the ensuing vague statements of support from other sets of finance ministers on Saturday have really not taken us very far.

Still, there is time for a make-up test (or two) on Sunday.  The US Treasury is undoubtedly working on some detailed measures to shore up parts or, hopefully, all of the banking system.  Eurozone member countries will be meeting in France on Sunday afternoon, presumably to see how far along they can bring the Germans – particularly with regard to systematic bank recapitalization.  It remains unclear whether anyone in the eurozone will suport the British ideas of blanket bank guarantees at this point.  And it is far from clear if the British will introduce the kind of overall package that in our view could turn the corner, even in a local sense.

The goal, as you know, is to get a clear strategy in place and well communicated by the time the stock market in Tokyo opens at 8pm (US East Coast time) on Sunday.  Let’s see how they do.

2 thoughts on “When’s the Make-Up Test? Tomorrow.

  1. Clearly, oodles of moral hazard is what the market needs right now, and this is a good thing to keep our system from breaking.

    There are important things they left out: what’s the definition of systemic? The unintended consequence of this is that anyone small will be out in the cold, left to die or vulnerable to be bought and swallowed up by the big guys. (This is what Prof Johnson warned about recently, so it’s more his idea than mine)

    Second, what is the price of this guarantee? Insurance should have a price
    Finally, what if a healthy bank like HSBC says, to quote Sarah Palin, “Thanks but no thanks”?

  2. Good questions. So far, one interpretation is that “systemic” means that big banks will be recapitalized, at least based on the UK (RBS, HBOS, Lloyds TSB) and the US (8 big banks). In both cases, the governments have not said that smaller banks will not be recapitalized, and both have additional funds earmarked for the purpose, so we can’t make a definitive judgment yet. But one strategy could certainly be to protect a small number of big banks and let them buy up assets from smaller banks that may fail.

    As far as the price, there are two possibilities. One is that the FDIC will charge insurance premiums for the new stuff it is insuring (such as new senior debt of banks). The other is that, in exchange for the insurance, the governments of the UK and the US are strong-arming the banks into accepting recapitalizations that they might otherwise not accept. In the US, rumor has it that the offer was presented on a take-it-or-leave-it basis, along with a strong suggestion that they should take it. (The US cannot just go ahead and recapitalize banks against their will, at least not without inviting lots of lawsuits.)

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