Dawn of A New Interregnum

According to the official website of the President-Elect, there are 59 days until inauguration. Let’s call it nearly two months.  The good news is that President-elect Obama has begun to name his economic team, the line up looks strong, and they have plenty of time to get their plans in place.  The bad news is that the banking system may not have that much time.

We are now obviously in a delicate political phase, in which the Bush Administration is winding down and the Obama Administration does not yet have real power.  This matters because the US banking system is in a worse than delicate phase.  Contrary to the statements of Mr Paulson earlier this week, core US banks do not appear to be stabilized.  The fall in equity prices this week was a cause of serious concern, and we discussed the causes and potential (unpleasant) cures in our WSJ.com article on Thursday morning.  Since then the situation has only deteriorated, seen most clearly in the credit default swap (CDS) spreads for major banks, which moved up through Friday. 

This increase in CDS spreads means that the market believes the probability of some banks defaulting has gone up.  This is striking because the Federal Reserve at this point can make sure these banks never run out of liquidity.  So what is going on?

Partly people in the market are not sure that all parts of all (global) banks will be saved.  And partly they don’t know where the money for a bailout would come from. This is not just about whether TARP is or is not available to recapitalize banks, it is also about the not-so-good relationship between Congress and the outgoing administration.

Ask yourself this.  If the Bush Administration felt the need to raise, say, $1trn – see this week’s much cited FBR report on the capital needed by the banking system – and sought approval Congress in December, how well or badly would that conversation go at this point?  Could the new Obama team help?  What about when the new Congress arrives in the first week of January – would that make any difference?

We are in an awkward stage, facing major economic problems and with a potentially distracted executive branch.  We need to find some new ways to handle this transition between presidents.  And fast.

One thought on “Dawn of A New Interregnum

  1. Hello
    I apologize I’m not an economist but having read your response in the WSJ including the 3 options you have proposed, I thought maybe some one could clarify some things. Your option # 1 (a repeat a TARP-type injection of capital ($410 billion) to all systemically important institutions because recent signs point to a possible repeat of another 9/15 – 10/14? type financial crisis) certainly appears unpleasant but very reasonable. I whole hardly agree that the big effect of the “bailout” was to restore investor confidence and prevent a “bank run” which may have led to a total collapse of our banking system, especially after the fall of Lehman Bros.
    So my questions are:
    1. Did any of the $390 million actually be used to acquire bad mortgage loans from the banks and would it help? It sounds like Paulson is not in favor of this approach anymore.
    2. If we develop another bank run type credit crisis and stop it with the $410 billion, could it happen again? Will we have enough money to continue this cycle. I know this might be a silly question but I really don’t have a clue. I mean banks appear to be holding on to cash. The Federal Funds rate is 1%, similar to what the US saw after 9/11. But at that time money market rates were also extremely low. Now some FDIC money market rates are close to 4%, so banks must be in worse shape then people believe. Were they hurt from Lehman’s collapse or are they over leveraged and scared that if a “bank run” ensues they have the capital to say afloat. I know you guys are advocating a large financial stimulus to help with the effects of this worsening recession, but can we as a global economy hold on that long.

    I’ll shut up now and wait for individuals much wiser than I to hopefully respond.
    Thanks
    Scott E. Pace MD

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