Does the strategy itself even make sense?
Banks are still lending as much as would be expected from experiences in prior recessions. But that's not enough for our credit-dependent modern economy, so we want them to lend more. Despite having $843 billion in excess reserves, they are unwilling to do so. In an environment with excess consumption and excess investment, that may be a perfectly reasonable decision. Banks want a better risk/reward proposition.
We have done a lot to force the reward prospects down in order to make borrowing more appealing to businesses and consumers. The interest available on mortgages and commercial paper, for example, is far less than that which would clear the market without government intervention.
We've also done a lot to limit risk faced by banks, such as FDIC-guaranteed bonds, loss absorption by the Fed, and implicit guarantees. The new offer to pay full book for grossly mismarked assets, despite some issuance of common as a token gesture, would be a risk reduction significantly larger than those already announced.
This should make the risk/reward ratio look more appealing, but this is just a mirage. It does not reduce the total risk; it only diverts some of the bank's risk to the Treasury and taxpayer. This diversion might be large enough, in which case loans will be made against the banks' better judgment.
The IMF has found recapitalization of this sort to be conducive to better economic outcomes. The Austrian in me is skeptical. I find it very hard to believe that further extension of uneconomical loans at abnormally low interest rates is beneficial either to the economy or sovereign credit.
One thing is certain: this will reinvigorate our climb ever higher on the debt-to-GDP mountain, a far more complex and interesting crag than I would ever have guessed. More on that later.
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5 comments:
it's clear at this point that at least some losses are going to be socialized but there are numerous problems with this proposal, including many obvious ones. how would the government know how to price these instruments to model? who is going to read the contracts? who is going to manage required cash flows in and out of these contracts? it takes a lot of lawyers, quants, and accountants to do this, and the quants can't even do it, really.
A compendium to this piece should be a discussion of cramdowns. This will roil the MBS market and add to the spring loaded rate pressure.
Marti Wolf covers the topic well today with a piece of total debt loads. He clearly articulates the options: growth, default or inflation. Everything else is just noise. These are the options. The second leg is the timing.
As far as bad bank, the admisnitration uis trying to make the argument that this is necessary to get the economy moving again. But peak debt has arrived. So even if you recapped the banks, why would they lenfd, to your point? Countercyclical lending is counterintuitive and welcomes massive adverse selection.
the lending argument is predicated on a macroeconomic fallacy that there is a demand "gap." This is simply not so. There is a dupply surplus. And surplus either get worked off over periods of time or they get destroyed. The abstraction is made more clear by things like commercial real estate and 6 different types of baked beans at the super market.
It is shockingly obvious that US GDP is massivily overstated. Indeed the FT runs a piece today talking about different ways of measuring outputr that relate better to economic realities on the ground. In the article things like intangible happiness are bounced around as key elements missing from the pure quantitiative. No mind you this study is being done by people like Stigilitz (who to his credit is calling BS on the bad bank model). if this is not the ultimate tell on western arrogance, not to mention ineptness, of the economic profession, what is? I would love to see Paul Krugman's analysis on how his covented fundamental accounting relationships work when the qualitiative is injected. the absurdity of economics grows every day.
Somewhere along the line economists forgot that thier's is a social science (whatever that means) not real science.
ndk said,
"The IMF has found recapitalization of this sort to be conducive to better economic outcomes."
If this were true, then Argentina would be the safest place to park one's money, right?
It never ceases to amaze me that when a government program fails to produce the required result, it gets expanded.
how would the government know how to price these instruments to model? who is going to read the contracts? who is going to manage required cash flows in and out of these contracts? it takes a lot of lawyers, quants, and accountants to do this, and the quants can't even do it, really.
All the same practical objections surely do linger on, babar, but I don't think they pose such an enormous obstacle that they won't be overcome.
Marti Wolf covers the topic well today with a piece of total debt loads. He clearly articulates the options: growth, default or inflation. Everything else is just noise. These are the options. The second leg is the timing.
I agree with much of what he wrote, but I don't really agree with his conclusions on the cure of growing out of the debt overhang. While it'd sure be nice if it could happen, I don't think it will, particularly because low real interest rates raise consumption while depressing investment. Forced lending by the government might change things a bit, but I'm not sure.
the lending argument is predicated on a macroeconomic fallacy that there is a demand "gap." This is simply not so. There is a dupply surplus. And surplus either get worked off over periods of time or they get destroyed.
I'm generally extremely skeptical of measures such as potential GDP and output gaps. It's clear there is a supply/demand imbalance right now, and many feel that increasing demand is preferable to increasing supply.
If this were true, then Argentina would be the safest place to park one's money, right?
It's a good point -- there are boundary conditions out there, and I think the UK in particular is close to one.
Cassandra has a usual over the top post on the inflation vs. deflation debate. Notwithstanidng the style, the argument is interesting, especially her out of hand dismissal of mellonites
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