That Worked (?)

At last, our long wait to learn the Administration’s policy on banking is over.  The policy is: wait. 

This message comes from Bernanke, Geithner, and other officials over the past few days.  And, in this season of attempted policy message convergence within the G7 (it happens or tries to happen twice a year, ahead of the IMF/World Bank ministerial meetings), it is what we are starting to hear on all sides (e.g., from Trichet, head of the European Central Bank): we’ve done a lot, our economies might recover, and we don’t want to overdo it.  So we’ll wait.

Looking just at the US economy or just at the Eurozone, this might make sense.  But recognizing at what is heading our way from Eastern Europe and other rapidly slowing parts of the global economy, “the risks are weighted to the downside” (an official euphemism that you will hear frequently in the coming weeks).  And the market is not so easily convinced that all is now well or even significantly better.

Look at what happened to the credit default swap (CDS) spreads on US banks yesterday.

This is a small improvement, presumably because people feel somewhat comfortable that the Administration has no immediate intentions towards junior bank debt.  And the drumbeat of positive spin from Messrs. Pandit, Lewis, and Buffett is having some effect – these are smart people, and they only put out such encouraging public words when their private information indicates that things are going much better.

Yet there is a tendency these days, even among leading global CEOs, toward tunnel vision.  They see what is directly in front of them and do not want to focus on the storm clouds that are gathering a mile up the road.  The roof has a massive hole, a hurricane has definitely been sighted, but it is sunny today.  Should we talk about how sunny it is and how the hurricane might vear off, or should we undertake some rapid roof repairs?  Should we focus on the level of CDS spreads or the latest tiny tightening?

The prevailing G7 official tendency in such situations is always: wait and see.  Sometimes this is a great idea and works out just fine.  Now seems unlikely to be such a time – it is far too easy to be overtaken, massively and disastrously, by events.  Ask Hank Paulson about his experience in mid-September 2008.

23 thoughts on “That Worked (?)

  1. perhaps time is needed to assess the damage done


    “…Only preparation for war and involvement in hostilities from 1941 pulled America out of depression… Perhaps the clearest lesson… is that war is good for output, employment and corporate profits… Yet there is another, perhaps no less gloomy, way to draw parallels between the present crisis and the Great Depression… The analogue of the 1929 Wall Street crash is not the 2007 credit crunch, but the bursting of the New Economy bubble in 2000… The difference between the years after 1929 and the years after 2000 is that the policy mistakes were almost opposite…”

  2. Warren Buffet essentially alluded to the Geithner plan the other day during his marathon CNBC interview: wait and hope banks earn their way out of insolvency. That will require giving banks enough capital to survive, but according to Buffet with interest rates at zero and spreads so wide, banks can have a field day now.

    But hope is not a plan. Eastern Europe is on a collision course with collapse, and Western Europe’s banks will bear the brunt of that. US banks won’t be far behind. Policymakers need to get out in front while there is still time.

  3. Yep, the more I read, the more I think you are dead right.

    The govt. is going to get widely criticized for the _visible_ wealth transfers, but it will be harder to criticize the _invisible_ wealth transfers to banks.

    We know Citi’s quarterly earnings (not accounting for writedowns) are high. They have free money, massive leverage, and high interest rate spreads. They can undercut every other bank in making secure loans (including Buffett’s) because their cost of borrowing is so much lower (thank you TARP and Fed). If the govt. goes further, and actually does retract mark-to-market, Citi can state large profits, which hopefully gets reflected in the markets and reflates asset values, etc.

    This creates the illusion of value, and eventually illusion becomes reality.

    Kudos if this works…


    1) The unpredicted shift in consumer behavior ends up being hard to undo – aggregate demand sees long term suppression.

    2) The media sniffs a rat; the charade falls apart.

    3) Data from the real economy destroys the illusion before the illusion can affect data from the real economy.

    Wow, what a gamble.

  4. There may be further storm clouds gathering over Asian banks as a result of the collapse of Asian exports and trade finance. China’s latest export figures are dismal.

  5. Doesn’t that overlook the situation that the good times were not necessarily a norm, but a bubble and the the pile on effects of what has already happened haven’t nearly played out yet? Who are the borrowers going to be, given the levels of leverage remaining and the earnings dominos still to fall?

    It seems to me that the wreck has happened, but the powers that be are still in serious denial.

    All they seem to be doing is turning Citi and company into bigger zombies and that will only cause more trouble down the road, not less.

  6. So with all the rhetoric in Washington, the answer is: status quo?

    Have Bernanke, Geithner and Co. succumbed to the political pressure of corporate, or do they really think that this may allow for a recovery without having to deal with the process that re privatizing these banks would entail?

    I can’t imagine someone of Bernanke’s background thinking this is the solution. I wonder what they all really think.

    Sounds like they are just gonna close their eyes and hope for the best.

  7. StatsGuy

    I agree – it is what they are doing – and I also agree – kudos – absolute kudos to them – if it works.

    And this guy – who is no fool at all – thinks it might well work.

    as does Bronte capital. These banks are earning a lot of money. That makes them harder to nationalize – which – pleases me. I am a Burkian – and want the least fuss and risk possible. The aim of this website here – which is to overturn the world just for the heck of it – has no appeal to me – if we can possibly avoid it.

  8. StatsGuy –

    And is this gamble more of a gamble than nationalization? I don’t think so. Congress would simply never allow full Federal assumption of the bank debt. There would be a populist revolt – which the web deflationists are stirring up right now. We are acting as our own Andrew Mellon – liquidating ourselves for the pure fun of it. Read Calculated Rick – or Naked Capitalism. They think deflation would be just dandy and fun.

    Congress would absolutely force a senior bank debt cramdown – and that would be the end of all things beautiful and true. The insurance industry would go bust – policy holders would run the insurance industry – and world wide asset values would just vanish.

  9. Is economics a “science” in the sense of physical and biological sciences? It is ultimately based on individuals and their behavior is it not? And is that behavior deemed consistent over time?

    Could it be that our previous economic indicators are in a state of dislocation between linear, simple cause and effect indicators and more holistic, synergetic, or circular models?

  10. You wrote: “…these are smart people, and they only put out such encouraging public words when their private information indicates that things are going much better.”

    Here is an alternative, significantly more skeptical interpretation: They are talking their book!

  11. re, “The policy is: wait.”
    A more complete statement may be
    “The policy is: wait; then bail-out upon request.”

    This makes it a bit clearer that a change in administrations has meant no change in policy.

  12. Can we be sure “waiting” is the strategy of Geithner et al. or could we be looking at what is more likely paralysis?

  13. “The roof has a massive hole, a hurricane has definitely been sighted, but it is sunny today.”

    More like: The leading edge of the hurricane has slammed ashore, and ripped most of the house apart, but we’re in the eye now, and the winds have died down to a managable 40-50 mph. And that black mass of clouds that is the other side of the eye wall fast approaching? Well, we’re worry about that when it hits.

  14. I hate to say this, but with Obama being the genius politician he is, I believe that he has realized that letting the economic situation get worse — until the Republicans utterly self-destruct or flee to him — is the way to get the power necessary to carry through the rest of his agenda (fight climate change, enact national health care, etc.) The rest of his agenda is in fact more important than preventing a Second Great Depression.

    Particularly fighting climate change, which threatens the survival of civilization — but also national health care, which will simply improve everyone’s standard of living even if unemployment goes way up.

    I hope Obama’s political estimation is correct.

  15. I think, in fact, that “wait” will make it FAR EASIER to pass nationalization through Congress. If “wait” is done correctly.

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