Interest Rate Roundup

Wednesday, January 28, 2009

The latest "solution" to the banking crisis

The banking stocks recently suffered another mini-crash. So it's no surprise Washington is responding with yet another "solution" to the crisis. Every few months, this happens. Some bank, broker, or subsector of the credit market blows up ... policymakers try to think up a solution ... that solution gets leaked to the press ahead of time ... financial stocks rally ... and then the whole sorry process repeats itself. It reminds me a lot of the Bill Murray movie Groundhog Day, where weatherman Phil Connors is forced to relive the same dreary day over and over again.

The latest news is that Washington will soon establish a "bad bank." It will reportedly buy toxic assets from banks, more than likely at inflated prices. Government officials will justify doing so by claiming today’s asset and security prices are “artificially” depressed by forced selling and that its “mark to model,” hold-to-maturity prices are more accurate. This process will make bank balance sheets look better and supposedly resume the flow of credit to the economy.

Other possible plans are also on the table, according to the Washington Post ...

"President Obama's top advisers are in the final stages of debating several perilous options to right the financial system, all of which are likely to prove unpopular and in some cases carry a significant risk of failure, according to sources in contact with the officials.

"The rapid deterioration of the economy has accentuated these hard choices. The health of many banks is getting worse, not better, as the downturn makes it difficult for all kinds of consumers and businesses to pay back money they borrowed from these financial firms. Conservative estimates put bank losses yet to be declared at $1 trillion.

"Senior administration officials are likely to try a combination of initiatives rather than pin their hopes on a single, all-encompassing solution to help the financial system, the sources said. But their strategy may require trial and error, which could make them vulnerable to the same criticism that dogged the Bush administration's fitful management of the $700 billion rescue program.

"On the table are several approaches, which officials have begun to experiment with on a smaller scale. One would give the firms a federal guarantee protecting them against losses on assets that are backed by failing mortgages and other troubled loans. Another would set up new government institutions to buy these toxic assets. A third would inject more money into financial firms in exchange for ownership stakes, perhaps ending with nationalization in all but name."

I hate to sound so cynical. But haven't we seen and heard this movie before? Haven't we been promised several "solutions" to this crisis over the past 18 months? And hasn't every single one ultimately proven to just medicate the patient, rather than cure the underlying disease? There's a very simple reason for that, one the politicians simply won't admit: There is no quote-unquote solution. Nothing ... NOTHING ... can prevent a painful adjustment process from unfolding.

I wish that weren’t the case. But the time to prevent this painful correction and deleveraging process was a few years ago when the bubble was inflating. If regulators, policymakers, borrowers, and lenders hadn’t acted so stupidly then, we wouldn’t be in this mess. But they did, we are, and no amount of talk out of Washington can change that fact.

Oh and by the way, the estimated cost of the credit crisis continues to rise. Just this morning, the International Monetary Fund (IMF) raised its estimate of the losses from the financial crisis to $2.2 trillion. Its October estimate was only $1.4 trillion. Just about the only certain thing associated with the latest bailout plan is that it will lead to billions and billions (and billions) more dollars worth of debt being piled on the back of U.S. citizens.


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