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Friday, April 24, 2009

U.S. Financial structure repair: Illusion of Progress?

The current banking situation is much worse than in the Great Depression. In the 113days ending Dec. 22, 2008 the monetary base increased 103.01%, an astonishing annual compound rate of 885%. The increase has had little apparent effect in solving the overall problem. Initially, we thought that if doubling the monetary base does not solve the problem, double it again, and again if necessary. The idea was that an ordinary liquidity trap (economy not responding to expansive monetary policy) can be overwhelmed by throwing money at it. But if Bank A fears that Bank B is insolvent (Bank B may not be insolvent but with an opaque balance sheet who knows?) it will not want to have interbank relations. Hence interbank relations freeze and dysfunctional zombie and vampire behavior, already experienced in the S&L crisis (Google: Mishkin and Eakins, p.488), poisons the system. The monetary base and excess reserves have been increased to an extraordinary degree but the increases have not solved the crisis. Apparently even a flood of money alone cannot eliminate a solvency trap. We suspect the only way to get rid of the problem is to clean out the rot as done by the RTC in the S&L crisis.

Pursuant to solving the banking crisis, it is hoped that some lessons have been learned from the S&L fiasco. Piecemeal certificate programs did not work. Regarding changing marking to market Michael Pento on CNBC mentioned about changing marking to market to marking to fantasy. Given how the CDO tranching models (and rating services) have failed who is going to trust new models? Finally, insolvent zombie banks should be seized by the equivalent of an RTC and dispatched. We question (along with Jeff Macke of CNBC’s Fast Money program) the “too big to fail” doctrine regarding Citi and/or Bank of America. Should we be held hostage forever by a so-called too big to fail zombie?

FDR's approach needs to be applied now: 1) identify the solvent banks and support their lending, 2) identify the insolvent banks and close them, 3) reorganize the marginal banks by stripping out the toxic assets even if temporary nationalization is required. The President of the Kansas City Fed has persuasively argued for this approach (Google: Thos. Hoenig, KC Fed) The current piecemeal approach, we suspect promolgated by bank and Wall Street lobbists which top eight spent 38.4 billion in 2008 on lobbying (Business Week 2/23/09. p.36) to buy time to position themselves to better profit from the 180 bil (and climbing) of TARP money received in 2008 (Ibid, p.36) is prolonging uncetainty and the credit drought. If this isn't sufficiently troublesome, top economists Stiglitz, Sachs, and the GAO Inspector General (Google: Barosky Report)have pointed to loopholes that permit banks to game the system, with the latter claiming incidents of fraud already occuring. The longer Washington plays footsie and fails to move with dispatch, the more impossible it is for the Treasury Secretary to implement a remedy that is effective and fair to taxpayers. As much as 50% of the hundreds of billions of bad debt in the banking system may with unsecured bond holders. When a bank is liquidated, common and preferred shareholders usually lose everything, and so should unsecured bondholders. Secured bondholders may recover 40%. We believe lobbying has slowed TARP implementation to a piecemeal rate in an effort to protect unsecured bondholders who don't deserve it, especially at the expense of speedy remedy.


Blogger ChiTom said...

informative & helpful. Thanks!

3:59 PM  
Anonymous Anonymous said...

An impressive piece of research and commentary. I hope that Krugman incorporates some of it into his sermons so it get international distribution.

2:34 PM  

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