Wait and See: A Less than Perfect Banking Policy

By Simon Johnson

At last, our long wait to learn the Administration’s policy on banking is over. The policy is: wait.

This message comes from Bernanke, Geithner, and other officials over the past few days. And, in this season of attempted policy message convergence within the G7 (it happens or tries to happen twice a year, ahead of the IMF/World Bank ministerial meetings), it is what we are starting to hear on all sides (e.g., from Trichet, head of the European Central Bank): We’ve done a lot, our economies might recover, and we don’t want to overdo it. So we’ll wait.

Looking just at the US economy or just at the Eurozone, this might make sense. But recognizing what is heading our way from Eastern Europe and other rapidly slowing parts of the global economy, “the risks are weighted to the downside” (an official euphemism that you will hear frequently in the coming weeks). And the market is not so easily convinced that all is now well or even significantly better.

Look at what happened to the credit default swap (CDS) spreads on US banks yesterday.

This is a small improvement, presumably because people feel somewhat comfortable that the Administration has no immediate intentions towards junior bank debt. And the drumbeat of positive spin from Messrs. Pandit, Lewis, and Buffett is having some effect - these are smart people, and they only put out such encouraging public words when their private information indicates that things are going much better.

Yet there is a tendency these days, even among leading global CEOs, toward tunnel vision. They see what is directly in front of them and do not want to focus on the storm clouds that are gathering a mile up the road. The roof has a massive hole, a hurricane has definitely been sighted, but it is sunny today. Should we talk about how sunny it is and how the hurricane might veer off, or should we undertake some rapid roof repairs? Should we focus on the level of CDS spreads or the latest tiny tightening?

The prevailing G7 official tendency in such situations is always: wait and see. Sometimes this is a great idea and works out just fine. Now seems unlikely to be such a time - it is far too easy to be overtaken, massively and disastrously, by events. Ask Hank Paulson about his experience in mid-September 2008.

Comments

[morph366:]

The best line from Geithner yesterday was:

"There’s capital that wants to come into the system, but it just can’t get financing"

Mar 11 12:15 PM

[jetski:]

Letting banks work out their toxic assets themselves makes sense. They are far more experienced at working out troubled loans than the sharpies who are drooling at the opportunity of bying troubled bank assets at fire sale prices with government financing and government guarantees. Instead let the banks work them out and give the banks the same kind of support they are proposing to give to the hedge fund sharpies.

Forbearance also makes sense, because maybe the banks will earn enough money to fix things themselves without any government support.

Mar 11 03:02 PM

[jetski:]

And the uptick rule should be reinstated immediately. The interests of our nation and having the money needed to implement some of President Obama's policies must take precedence to profits of short sellers. For example it was reported that Paulson made half a billion shorting Lloyds. How much was made shorting citi and bac and all of our financials?

I wonder what Markopoulos thinks of Mary Shapiro? He said FINRA was in bed with industry.

The shorts profits should be heavily taxed and used to provide stimulus.

Mar 11 03:12 PM

[Lilguy:]

I am all in favor of waiting IF it is highly likely that the current polices of the Administration and Congress will result in ending our current recession, ending the banking industry crisis, stabilizing the home real estate and mortgage markets, and assuring that drop in employment is reversed.

Clearly that is what the White House, Treasury, Fed, and Congress all believe. We have provided all the ingredients and they just need to marinate, stew, percolate, rise, or whatever cooking analogy you'd care to mentione and, before long, voila, the economy and all its parts will be perking along again.

I believe that the Administration's and Congress' GAO's assessment of our economy situation is overly optimistic, just like almost all economists in the business and academic world. (Key exception: Nouriel Roubini, who has hit most forecasts on the head.)

As a result, I think the stress tests Treasury is using on the banks do not adequately represent the severe stress that both exists now and is even more likely to exist in the months ahead.

I believe that the policy instruments in use by the Treasury, Fed, and other federal agencies are, therefore, inadequate to meet the crisis into which we are falling even more deeply.

I believe the senior executives of most major American companies are using the crisis to extort taxpayer funds to cover the massive financial mistakes they have made. And they will continue to do so until they are replaced.

Unfortunately, I believe the decision to wait will cost the American economy and the American taxpayer much more than if the Administration and Congress acted quickly and thoroughly to, in particular, nationalize/pre-privat... the insolvent banks and other corporations (GM, AIG, etc), replace their management, decimate their shareholders and bond holders, wipe out the bad debts, and re-privatize the elements of each that show some promise of being going competitive concerns.

Regrettably, we have chosen to wait.

Mar 11 05:04 PM

[jeerio:]

The Wait is necessary, even though it's clearly not desirable. the scope and depth of the problem is so severe, our economic and social systems couldn't absorb the additional shock...so we wait, and in the meantime, we adjust to this new American reality of diminished future expectations.

Mar 11 10:13 PM

[John Lounsbury:]

Lilguy - - -

Excellent comment. You give one side of the argument very well. The government is overly optimistic about recovery.

The budget assumption is for a 3% GDP growth in 2010.

The Fed's stress test assumes the extreme stress case is 3.3% total drop in GDP for the recession. As of yearend 2008 we are already halfway there and will be somewhere in that area by the end of this quarter. This (-3.3%) should be the standard stress (or even stress lite). The extreme case should be at least -5% and possibly -6%.

The risk of waiting is that the spiral down will not be stopped in a timely way and the recession deepens more than it would have.

jeerio - - -

Good comment from the other side of the argument. We do not have the many trillions available to put an end to the uncertainty for certain. We can't afford to fix everything in real time. We have to let time do it's thing in sorting out the solvent from the insolvent.

My summary - - -

Trying to influence this economy is something like trying to keep a car with a stuck throttle and no brakes in the middle of the road until the fuel is burned up or the throttle becomes unstuck. We hope for some uphill grades to slow the speed, but, otherwise, we just want to stay out of the ditch. We can work on the stuck throttle, but not so much that we take both hands off the wheel and our eye off the road.

Mar 11 11:24 PM