Forex Blog - Obama Inherits Insolvent Banking System
Obama Inherits Insolvent
As the former junior Senator
from the state of Illinois, Barack Obama, prepares to be sworn in as the 44th
President of the USA and the nationâ€™s first African American President, one can only be
elated at the accomplishment of the man and the nation. It is a great day
for America and the world.
And with a little luck and
lots of correct decisions, it may well be a great new era for America and the worldâ€¦I would not for a minute underestimate
this new soon to be US President.
That said President-elect Obama
knows all too well that the challenges ahead are enormous, arguably the most
daunting for any President since FDR put his hand on the bible in March of
1933. He has picked a competent team â€“ tax evasion indiscretions aside (I
do think fudging on taxes is wrong, especially wrong for a head of the NY Fed,
but I also think Geithner has more positives than this negative and believe
redemption will make him work ever harder to do the right thing ahead) â€“ to
tackle this financial crisis come economic crisis. This is the
nearly the best and brightest and a huge upgrade from what we are leaving with
the departure of the 43rd President.
But not even a very smart
President with a very smart and capable set of advisors can wish away a broken
banking system. And it is not just a broken US banking system. It is a broken international
banking system â€“ large global banks everywhere are facing insolvency
issues. Nouriel Roubini this week said the losses in the US banking system may reach $3.6trln making it effectively
insolvent. Currently banks have accounted for about half this amount in
losses. And they have no place to raise capital other than from
respective governments. BOA sold shares to the public in October at $22
and today its share price is a little above $5 and this follows a government
rescue package worth about $140bln announced this week. Arguably the
Paulson fallacy (think partly shared by Bernanke who admittedly makes monetary
policy not fiscal ones and hence has little choice but to go along with
Paulson) was that if the government could support banks in the short-run and
buy some time, with the Fed making liquidity virtually free, credit creation
and the multiplier effect would respond and short-cut a real economy
slowdown/recession. Well we know how badly this response wentâ€¦for many of
us we knew from the get go that anything short of nationalization was pothole
filling on the Brooklyn Queens Expressway. The banking crisis was much
bigger than buying time to allow bad assets to recover and banks to pass free
liquidity from the Fed onto customers.
So Obama has to build an alternative credit creation machine outside
the 9, now 8, large US banks where the bulk of the heavy lifting in the US and global financial system takes place. I am
sorry but solid regional banks are not in any position to fill the void.
Nor are newly received GSEs or the FHLB system. Nor are credit card firms
or student lending firms. The government needs to become the credit
creation machine in tandem with the Fed doing the smaller chore of supporting
non-large-bank credit markets.
I am not sure even Obama and
his economics team are ready to go Nordic on US insolvent banks and become the
banking system to the domestic and international economies. This is
socialism. This is un-American. This is repugnant. We are
where we are because of our Adam Smith DNA and blind faith in markets.
And free market advocates have had no better home than in financial markets of
the last decade or so. Markets work most of the time but not all of the
time and are prone to asset bubbles. Central banks will have new mandates
ahead to address asset bubbles and not simply assume there is no way to
identify them much less use policy to unwind them.
Government spending will get
bigger ahead. The $825bln the House Democrats and the transition team
have cooked up is the first in a series of similar sized tax cut and spending
measures which like TARP will fill potholes in the private sector but not
restore confidence in the banking system and asset markets.
To get in front of the
problem, the first priority should be ending the make believe private banking
system â€“ Japan tolerated zombie banks for far too long and saw a
decade of stagnation/deflation. No one wants the government running the
banking system for a minute longer than is necessary. But not taking over
insolvent banks and balancing the books because the thought of nationalization
is repugnant is a ringing endorsement of the zombie economy Japanâ€™s policies supported as late as 2005.
I am not saying it canâ€™t be
done. Obama has demonstrated time and again that the impossible is
possible. Moreover, he is an all in kind of playerâ€¦his hand is not great
but he has no choice but to play and play hard high stakes poker.
And there is some basis for
optimism as political support builds for a nationalized bank to buy bad assets
from banks disguised as the new RTCâ€¦toxic waste recycling center. Still
as UK developments showed this week, time is not on the side of deliberationâ€¦it
is time to act and act decisivelyâ€¦seize the broken, shed the assets and direct
credit to households and firms before the zombie hosts take over.
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