The problem is that a significant portion of the very biggest banks are insolvent. And on top of that, most of them have very large capital markets operations which have bean the nexus of credit intermediation. The regulators spent the last decade plus being in studious ignorance of those businesses, at least the complicated ones where all the risk resided. The SEC never was very interested in bonds, and the Fed took a hands-off, “let a thousand flowers bloom” approach to risk management, derivatives and what was called innovation. Author and market observer Martin Mayer warned “a lot of what is called innovative is simply a way to find new technology to do that which was forbidden with the old technology.”
But the history of major banking crises unambiguously shows that insolvent financial institutions need to be resolved. There are variations on the theme: the government can take them over and recapitalize them, clean them up and re-sell them, a la Sweden; you can wipe out equity investors and bondholders; you can try new twists, like various good bank proposals that have surfaced lately (making new entities out of the deposits and good assets and leaving the dreck with the existing bond and shareholders). While there would be many important details to be sorted out, this is not path breaking, except in the scale at which it needs to occur. And now, having had four actute phases of a credit crunch, the Fed and other central banks have plenty of liquidity facilites ready to deal with any initial overreaction. Rest assured, although radical measures would not be pleasant or easy, there are plenty of models and precedents.
But…here we have another scowling Treasury secretary, with a bit more hair than his predecessor, serving up the same fatally flawed approach as before: let’s just throw money at the banks and hope they get better. This is tantamount to using antibiotics to treat gangrene.
Why, I wonder, is it so hard to figure out that sometimes the very best thing to do, is do nothing. We almost instinctively “get” that in interpersonal or interfamily finances, or within our local communities. When we reach the state or federal level, however, we seem to think that, somehow, the game has changed because it is a bigger game. It has not. Let the market work itself out. Some will fail. Some will succeed. Others will form and grow to replace the failures, depending on the demand for their services or goods. This isn’t rocket science.
I don’t think Geithner or Obama are up to this challenge, but what the people want, the people get, I guess. Too bad for the rest of us.
The Financial Times has pointed out that we are now in the fourth phase of this crisis, and that each of the preceding three have been marked by ever-increasing government interventions, followed by ever-increasing value destruction in the financial sector. It looks as though Geithner is going to keep the pattern going with this latest limp plan – though I hesitate to call something so lacking in specifics a “plan.” Apparently, the market feels the same way.
But, hey, Barry told us there was not a single other person that could do the SecTreas job. Hopefully, that was just another shading of the truth, or we’re in a lot of trouble.
Both the previous and current Treasury chiefs come from the same community of investment banking and high finance big shots. There doesn’t seem to be much difference in their thinking, without regard to which President appointed them. And yet there are financial gurus and writers who have what seem to be better ideas. Why can’t we get these ideas tried?
There is, quite simply, too much toxic debt out there to hide it all in some cockamamie government scheme. These banks need to write down these loans and go belly-up if they are no longer solvent. Only then will we get rational pricing of these assets and a return to sanity.