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The Mother of All Bailouts
Tweet Share on Facebook September 19, 2008 Comment (1)Watched Bush. Watched Paulson. I have a hard time believing that Congress is just going to write a blank check and not require something out of Wall Street beyond greater regulation down the road. Recall for a moment what Sen. Chuck Schumer wants to do. He wants an entity that would "provide capital to struggling financial institutions in exchange for an equity stake in the banks." In other words, he wants a more AIG-like solution and one more similar to fixes seen in Japan and the Nordic countries during the 1990s banking crises.
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4 Ways to Turn a Recession Into a Depression
Tweet Share on Facebook September 18, 2008 Comment (15)Hoo, boy. Wall Street, as well as America's Investor Class, ought to find the following statement reassuring. Here is Senate Majority Leader Harry Reid on the credit crisis, "No one knows what to do. We are in new territory here." Well, my first piece of advice would be to do nothing. Punish Wall Street? The market is already doing that. Crack down on super risky home loans? The market is already doing that, too.
Moving forward, however, Washington might want to crack open some history books and examine just how bad policy from Washington turned an economic downturn into the Great Depression. Here are handy tips for what not to do:
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Big Government's Big Role in the Credit Crisis
Tweet Share on Facebook September 18, 2008 Comment (9)"The private market screwed itself up, and they need the government to come help them unscrew it." So says Barney Frank, chairman of the House Financial Services Committee. Did Wall Street make mistakes? Absolutely. But so did our fellow Americans who took out loans that they shouldn't have.
And so did Uncle Sam. The more you look at the history of the housing-spawned credit crisis, the more you notice Uncle Sam popping up, Zelig-like, in every scene. Fannie Mae and Freddie Mac were government-birthed entities that decided to buy securities tied to subprime loans. And it was government officials on Capitol Hill, the recipients of millions in campaign donations from the F&F lobby, who decided not to rein in those entities. You had the government ' s Community Reinvestment Act nudging banks to make unsound loans. Government banker Alan Greenspan pushed interest rates too low for too long earlier this decade, creating an extreme financial situation that made the crazy Wall Street strategies look temporarily reasonable. And for decades, government has pushed higher homeownership as a national goal, via F&F as well as through the tax code, siphoning off resources that might have been better devoted to other economic sectors.
And now, folks like Barney Frank pretend government just showed up on the accident scene moments ago like an innocent passerby who wonders aloud, "Anyone here know what happened? Anyone?" I mean, how can we try to prevent future financial crises, or least minimize their damaging effects, if we delude ourselves on the causes of the current one?
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The Fed and the Zero Handle
Tweet Share on Facebook September 17, 2008 Comment (2)When I noticed just now that the three-month treasury bill was, like, almost 0.00%—actually 0.04%—it did not compute. What that means is that people are desperate to find super-safe places to park their money. (That fear can also be seen in the $80-plus jump today in the price of gold, considered the ultimate safe haven.) There is a now a nearly 2 percentage point spread between three-month T-bills and the federal funds rate. Economist extraordinaire Mike Darda makes an interesting point: "There were similar inversions between T-bills and Fed funds during the crises/recessions of 1973-1974 and in 1980-81 just before large reductions in the Fed funds rate took place. If the Fed were to follow the T-bill yield down, the funds rate would now land at zero." Me: If a fed rate cut was what it took to fix things, I am sure Bernanke would have rather done that than launch rescues of Wall Street firms.
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Wall Street Woes: How It Will End
Tweet Share on Facebook September 17, 2008 Comment (4)Being a movie buff, I always look to films as a handy metaphor for whatever is going on in the world. One of my favorites right now, as it was back during the technology stock bubble of the 1990s, is The Matrix. It is a movie about two realities, one virtual, one concrete. As I wrote about the tech stock bubble back then: "Internet stocks seem to exist in some Matrix-like virtual reality where a completely different financial physics applies. In this Web wonderland, revenue growth would always accelerate, prices continually advance, and actual profits forever lurk just around the bend."
The same scenario strikes me today when it comes to current events. You have the financial economy—Wall Street—where the fundamental, inescapable realities of risk and reward were ignored, and which is now suffering a tremendous upheaval. And then you have the "real economy," where Main Street exists, which is chugging along for the most part despite the housing implosion and credit crunch.
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Dr. Bernanke Turns Into Dr. No
Tweet Share on Facebook September 16, 2008 Comment (3)Investors wanted a bailout of Lehman. Ben Bernanke (and Hank Paulson) said "No." Investors wanted, or at least expected, an interest rate cut. The Fed chairman said "No" again. Now, while it may seem like Bernanke has been reading too much Andrew Mellon lately—the treasury secretary who favored a financial bloodletting at the start of what became the Great Depression as a way of purging the "rot" from the system—what he is really doing is playing the cards dealt him the best way he knows how. There is zero indication that a rate cut would have done much good. As economist Mike Darda writes this afternoon:
The Fed decided to buck market expectations (which were pricing in more than an 80% probability of a 25 bps rate cut) and stood pat with short rates at 2%.... [We] believe the Fed is correct to try to deal with current credit strains with its special liquidity facilities and the discount window rather than to run short rates down from an already low 2%. The financial system is suffering at the hands of a solvency crisis, which is creating a contraction in credit and a breakdown in financial intermediation. Cutting short rates from the 2% level won't solve this problem.
Me: I just noticed the Dow is up more than 100 points. Mr. Market is calling this one right.
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McCain's Right: The Economy is 'Fundamentally Sound'
Tweet Share on Facebook September 16, 2008 Comment (11)John McCain has taken a lot of grief for repeatedly saying "the fundamentals of the economy are strong," including yesterday, on Meltdown Monday. (Of course, McCain has also said the economy's "in a shambles.") So, what's the reality here?
1) Wall Street is in a recession (autos and housing, too), but the overall U.S. economy is not. The economy probably grew at close to 4 percent in the second quarter and is expanding at near 2 percent in the third quarter.
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Washington Makes Wall Street Gloomy
Tweet Share on Facebook September 16, 2008 CommentUncle Sam is making it tough for investors to be upbeat. Take a peek at this analysis from Morgan Stanley (bold is mine):
The bottom line is that we look for the F2009 budget deficit to rise to US$540 billion (3.7 percent of GDP), and in 2010 our estimate is US$450 billion (2.9 percent of GDP).... The outlook is gloomy— but hardly unprecedented. Note that our budget deficit estimates for 2009-10 are somewhat larger than those just published by the CBO. This is due to a number of factors. First, our near-term outlook for the US economy is weaker than that of the CBO. Second, the CBO's estimates do not include an extension of the AMT fix. Third, the CBO assumed only US$20 billion of outlays for the GSEs. Fourth, the CBO's estimate for FDIC outlays is lower than our own.
In the longer run, we expect tax rates for individuals to go up after 2010 regardless of who wins the election. This, together with a recovering economy and a likely flattening out of defense spending, should help to bring the budget deficit back down to US$300 billion or so by 2012. Obviously, the US still faces severe budget pressures beyond that point due to sharply escalating outlays for Medicare and Social Security, but these forces don't become too drastic until later in the decade.
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McCain and the Gang of 10
Tweet Share on Facebook September 16, 2008 CommentSome of the McCainiacs I know are worried that the GOP nominee is going to throw away the energy issue by signing on to the so-called Gang of 10 energy compromise effort. (It would seemingly allow expanded oil drilling, greatly expand biofuel programs, increase dough for nuclear fuel research, and increase taxes on oil companies.)
- My Capitol Hill sources don't think there is going to be a compromise with broad support.
- Team McCain doesn't think there is going to be a compromise with broad support.
- If a workable compromise came together, he would likely vote against it.
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When President Obama Buys Wall Street
Tweet Share on Facebook September 15, 2008 Comment (3)Barack Obama has a lot of things he wants to do if elected president: quasi-nationalize healthcare, institute a cap-and-trade climate change plan, invest hundreds of billions in energy and infrastructure and education. What he does not want to do, I would imagine, is deal with an ongoing credit crisis on Wall Street. An adviser to the campaign told me that Obama has "contingency plans" to deal with the problem if it does not seem to be improving in 2009. (Already, he seems to be backing off his tax increases.)
Surely, one of those options may well be for the government to either take bad debt off the hands of the banks or take equity stakes in troubled financial institutions, or both. Former Treasury Secretary Larry Summer has written recently that "consideration should be given to whether the government should establish a mechanism for purchasing assets from stressed banks in return for warrants or other consideration. " And commenting on what Summers wrote, economist and blogger Brad Setser writes: "After the U.S. election, I suspect the debate will shift toward the need for such a systemic solution. If this kind of intervention proves necessary, it would need to be accompanied by a rather wholesale change to the United States' system of financial regulation."
