A guy steps on a landmine and blows his leg off. You apply immediate pressure and get a tourniquet on to slow the bleeding. You get saline or plasma or blood into him to keep the fluids up. Then you get him to a doctor to evaluate the wound and decide how much of the leg can be saved and where the amputation will take place.
Lehman Brothers was the land mine. The Feds moved swiftly to stop the bleeding by parsing up the worst case banks and selling them off to other entities. They started to inject fluidity into the market through Bailout I and lowering the prime rate to near zero - trying to keep the 'blood volume' up. Obama knew that there would be some lead time to get the Stimulus I bill through Congress - so I don't mark him down for getting that 'therapy' effort started before the amputation occurred. But then, last week , IMHO, the Feds should have taken over Citibank, paid the deposit insurance, and begun to liquidate it. Same for AIG. Same for GM. There is no recovery for these three institutions - no recovery which doesn't hurt some other stronger player in their respective markets such as JPM and Ford (who is a peer for AIG? oh, some French company). After Obama's speech the other week, he gained some momentum back but that I still feared that the Geithner/Summers lacked the ruthlessness to do what needed to be done. The Administration's latest maneuvering on Citi and AIG prove that. Some say that the Feds can't liquidate Citi - that Citi is so big that the Feds can't properly manage the liquidation. And AIG is even bigger. Oh well. Extraordinary times and all that. Suck it up and take them down. Citi has failed. AIG has failed. GM has failed. And Obama has failed with them.
Maybe I am being too hasty. Maybe there is an elegant "destructuring" plan in the wings for C and AIG and GM. But I doubt it. Guess we'll know in the next few months. But the needle in my meter has swung from "patiently waiting" to "assuming the worst." And, no, I don't think that the "the fundamentals of the economy are basically sound" candidate would have done better.
Giving intravenous fluids to a victim with an arterial bleed doesn't solve the problem. But it's an important step if you want to improve the patient's chances. The guys who did not want to give money last fall would have killed not just some of the biggest banks at the top, but the whole freaking modern banking system. We would have lost not just a leg but the whole patient. Shock can kill, as can bleed-out. How long do you think the USofA could have survived without international credit? How much gasoline do you have stashed? How much fertilizer?
The problem, as I see it, now that the initial system shock has been dealt with - the Geithner/Summers/Bernanke aren't willing to cut off the damaged part of the leg. A charitable explanation is that they can't. That the Feds can't shutdown a multi-trillion dollar international bank with massive assets in indeterminate mortgage securities. I have some empathy for them. But despite their lack of knowledge, skill, confidence, man-power, other resources, whatever ... they are the guys charged with saving the patient. They appear to have confused that with trying to save the leg.
There is a chicken-and-egg issues for the major banks. They are holding trillions in mortgage backed securities that are currently worth less than when the banks bought them. If the banks were forced to 'mark to market,' the subsequent debt:asset ratios would require the Feds to step in and shut them down (or so I've read). But if the banks would start lending more vigorously, then the housing market would rebound and the mortgage-backed securities would be worth more again. Chicken-and-egg. Housing values and available credit.
There are three ways to evaluate those mortgage-backed securities.
- Pretend that they are worth whatever the banks paid for them or some arbitrary discount.
- Pretend that they are worth some % value of the underlying property values of the mortgages that the securities trace to
- Evaluate them at their 'street' value (which is something between 5-25 cents on the dollar).
I think that the market kind of froze itself with some version of '1).' With the Federal regulators and bank managers all pretending that the banks hold assets that are worth roughly what the banks said they were worth a year ago.
'3)' is the 'market solution' As I understand it, if the government required banks to report the asset:debt ratio based on the market value of their securities, all the major banks (at least their commercial and retail bank divisions) would be legally insolvent.
I think the Feds are trying to move the banks to some version of '2).' But the mortgage-backed securities aren't necessarily directly traced to individual mortgages, so it's hard to reassess them. And in today's real estate market, they are probably looking at a 20-30% markdown of even the best of these securities. More for the bad ones. Which would still leave many banks officially insolvent.
Now many people believe that this downturn is 'temporary' or that it is a dime-store recession. Just a bit of panic caused by politicians and the media. That the underlying economy is strong. If you believe that, there is a case to be made for propping up the banks for the few months or one year needed to see housing values rebound. Because as the housing values come back to their 2007 levels, the banks mortgage-backed securities will come back up as well. And the debt:asset ration will suddenly improve for many banks - maybe for most of those that appear insolvent today. The Feds just have to prop them up until the housing market recovers while lowering interest rates and provide tax credits to try to generate more buying. And the few trillion lost during that year of propping up could be recovered by a strong and growing economy.
But, if you believe that we are seeing a housing bubble collapse, as I do, then housing prices won't "recover." A housing "bubble" means that house prices were run up above their "real" value by artificial demand caused by such things as interest-only loans, sub-prime loans, and house 'flippers.' What we are seeing is housing return to "real" values (of course there will probably be some overshoot and some small recovery from that). So playing a waiting game with the banks is a losing proposition - you can't keep them afloat long enough for prices to recover because housing prices are not going to recover. (Eventually, inflation will increase the price but that's not an increase in value).
From what I can see of the Fed policy, they are trying to play the "prop the banks up until housing prices recover" game. From my point of view, that means that the Feds are trying to "reinflate" a housing bubble. They are trying to put the economy back on the same track it was on for the first half of this decade but we already know where that track leads!
As for the stock market, because most home owners are losing home equity at an alarming rate, they are reluctant to add new debt. They too have a debt:asset ratio even if it is just a subconscious tally. As their major asset declines, they move to eliminate debt until that ratio is back in their comfort zone. So spending will decline which means that corporate earnings will decline which means that the stock market will decline - above and beyond the declines due to the uncertainty surrounding the banks and GM.
The Feds cannot stop the housing decline because it is an adjustment of the housing bubble. Therefore they cannot stop the credit crunch because banks have to build cash to adjust their debt:asset ratios. Therefore the only good the Feds can do is to take down the 'losers' as cleanly as possible. A good clean amputation.