Why the Financial Markets Haven't Responded 30 comments
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The stock market has experienced a serious decline since the passage of the Paulson Plan. The money and bond markets still seem to be frozen in spite of a coordinated cut in world central bank target rates. The only way that this behavior can be explained in my mind is that without strong leadership -- from the very top -- the financial markets will continue to be weak. Even though others -- Paulson and Bernanke -- have tried to provide some form of leadership, the leadership that must be exhibited from the very top continues to be missing. (See my post of September 25, The Absence of Leadership.)
Missing this leadership, members of the Bush 43 administration were hoping and praying that events would be relatively quiet until they were able to sneak out of Washington in January 2009 and let someone else handle the situation.
They didn’t make it.
And, like any other organization that does not have a leader, good people with good intentions when faced with calamities try to come up with some plan or some action that will plug the hole in the dike. The problem with this is that when they have to work around the leader, there is no unifying force present in such situations, no calm hand on the tiller listening to alternatives, asking questions, and guiding responses. And there is no one around to punish dissidents.
Up until a couple of weeks ago, Treasury Secretary Paulson and Fed Chairman Bernanke tried to band-aid the system, proposing temporary responses to the growing crises that would tide things over until the new government came into office to deal with the problems. It seemed as if Paulson and Bernanke had reached a game plan; a bailout took place for Fannie (FNM) and Freddie (FRE), Lehman (LEH) was to fail with no help, and nothing would be done for [[]AIG].
Then, it appears by all reports, Bernanke reached a turning point.
Bernanke called Paulson and indicated that the financial markets were falling apart and that if nothing were done the economy might not be there the next Monday. The Congressional leadership had to be informed of this development and brought on board for a major flood of liquidity. In no instance could the financial system and the economy come up short of liquidity. Paulson set up the meeting with the Congressional leadership, and at that meeting Bernanke poured out his story of woe. According to some of the members of Congress that were there, Bernanke scared the life out of them!
One question needs to be asked at this point: Where was the “decider”?
The Treasury plan was assembled as quickly as possible for passage by Congress as quickly as possible -- no hearings, really, no questioning, things were so bad that there was no time for these niceties that could take place when things were not so dire.
And, then the financial markets froze!
Why not?
Here was the Chairman of the Board of Governors of the Federal Reserve System saying that the economy might not be there on Monday. What did he know that market participants didn’t? What was going on in Europe and elsewhere? Here was a major case of asymmetric information. And the people who were without information were the suppliers of funds.
Bear Stearns had failed. Merrill Lynch (MER) had failed. Fannie and Freddie had failed. Lehman had failed. Washington Mutual (WM) had failed. AIG had failed. Wachovia (WM) was failing. Who was going to be next? What did the Fed and the Treasury know that market participants didn’t know?
The initial effort to get “the bill” through Congress failed too. There was no one in a leadership position who could call the troops to order. (Even presidential candidate John McCain rode out at the head of his cavalry to lead the charge to get the bill passed, only no one followed him. Paulson could not do it, he was not the leader; there was no leader.
The “decider” was marched out -- but he only mouthed the words that were given. Why should anyone have any confidence in what was being done?
So, is the bill passed last Friday any good? After what went on in the two previous weeks, the bill seems somewhat irrelevant-- a very costly irrelevance. There is still no vision going forward. There is no strategy. There is no structure. There is little or nothing. At best we are told that maybe in four weeks the “Paulson Plan” will be up and running.
That will be after the election and we will have a president-elect. But the president-elect will have to wait for over two months before he can do anything about the financial crisis.
Meanwhile the Fed floods world financial markets with liquidity.
Bernanke’s study of the Great Depression taught him that during such a crisis, the world cannot have too much liquidity. And so, “Helicopter Ben” is acting on that premise. Total reserves in the United States banking system, for the two weeks ending September 10, averaged about $44 billion on a non-seasonally adjusted basis. For the two weeks ending September 24, the total reserve figure was about $111 billion. Never has the United States banking system received so many reserves so rapidly. And look at the sources and uses statement of the Federal Reserve System (the H.4.1 release). In the last three weeks the sources of reserves in the banking system increased by more than 50%!!!!!
Never have we seen anything like this! Never!
This is what happens when there is no leadership. One cannot blame this situation on previous administrations or other conditions within the world. The current leader of the free world is MIA.
Unfortunately for the financial markets, for the economy, for workers, for families, for everyone else, there will not be a new president for several months yet. And, we still have to uncertainty with respect to what the newly elected president will do. Will he, when in office, be able to provide the leadership that is so badly needed?
So, there is still an enormous amount of uncertainty with respect to the future, and this enormous amount of uncertainty will reign in the markets until such leadership surfaces. Meanwhile, the financial markets will still remain tentative as they attempt to discern who will fail next…and then next after that…and then next after that…
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This article has 30 comments:
The key here is that USD as a sign of confidence from foreign investors. Contrary to an emerging market crisis the dollar is going up for the most part telling us that money is coming to the U.S. The confidence for people to send money here will prove crucial to the healing.
On the contrary things are behaving rather well and three months from now we will view this is the greatest stock buying opportunity of the last few years.
I recommend that author to read about EM crisis in order to understand things a little better instead of running around like a headless chicken.
Longer term, I guess it would take a while for things to heal and for the excesses to be corrected. We have lived on borrowing since the 1980's and that is coming to an end.
There could be an generational dissapointement with equities heres.
markets have not responded yet because the hedgie funds are still dumping their overleveraged positions, throwing babies out w/bathwater.
> jack
Quite the politics; the market is not political. Investors looked at the underlying value of the asset of the differing investments and realized they were way overpriced. Real Estate has historically appreciated at about the same rate as inflation. But in 2000 real estate started to appreciate greater (2x to 3x) than inflation - simple because of EASY MONEY. Economics 101 - too many people with too much EASY $ chasing a limited resource = Higher prices. Then the bubble popped. What did you expect????? In 1999 the leaders did say we needed to pull things in on credit - did we listen??? Hell no, because we wanted our cake and to eat to.
This is true for any form of organization, business, government, not-for-profit, sports team, religious, or academic.
Can you imagine a quarterback putting up with team mates that question the plays that are being called?
This leadership is not present in the current financial and economic situation! As a consequence, no one really knows what is being aimed for and how it will be achieved.
If the running back or the guard has to take charge of calling the plays because the quarterback is missing, how are the other players on the field to really know where they are to go?
I guess dumbya didn't like the poll numbers and this is his way of getting even.. he'll have his house and fat pension and medical insurance after this disaster, that's all that counts.
I'll finish with this quote from a great American writer... if you can guess his name you win the prize...
"The president we get is the country we get. With each president the nation is conformed spiritually. He is the artificer of our malleable national soul. He proposes not only the laws but the kinds of lawlessness that govern our lives and invoke our responses. The people he appoints are cast in his image. The trouble they get into and get us into, is his characteristic trouble.
Finally, the media amplify his character into our moral weather report. He becomes the face of our sky, the conditions that prevail. How can we sustain ourselves as the United States of America given the stupid and ineffective warmaking, the constitutionally insensitive lawgiving, and the monarchal economics of this president? He cannot mourn but is a figure of such moral vacancy as to make us mourn for ourselves."
Its time we mourn for ourselves people, for WE did not get here by accident.
Not a good comparision because a quarterback knows the game better then his teammates that is why he can lead. If he did not know the game he could not call the play and he would be better off letting some who knew the game call it!!! That is what happen in this bailout. I however do not agree with the play as I think the play caller and his former teammates (not present teammates),had too much to gain by the play he called.
Not a good comparision because a quarterback knows the game better then his teammates that is why he can lead. If he did not know the game he could not call the play and he would be better off letting some who knew the game call it!!! That is what happen in this bailout. I however do not agree with the play as I think the play caller and his former teammates (not present teammates),had too much to gain by the play he called.
you are the one that has no clue wandering around without a clue and making dumb statements
Thanks for the quote. Exactly what I am trying to express.
davesilb
But, the quarterback has supposedly learned the game from others, has coaches that continually supply him with information, has learned what plays to call in different situations, and is supposed to inspire confidence in his play calling. That is supposedly why he is the quarterback.
If the quarterback cannot call the plays and cannot inspire confidence...the whole team suffers and the resulting execution of the team can be pretty dismal.
Net/Net: We have met the enemy...and he is US!
Stop blaming Bush, Clinton, Congress, etc, etc., ...and simply look in the collective mirror. Until we "grow up" as a society and get back to some core values, we have no one to blame but ourselves.
Not that Bush isn't culpable. The administration's goal of home ownership for all, regardless of the human capital these individuals bring to the table, has been disastrous. Look at where most of the foreclosures are. California, Nevada, Arizona and Florida have one thing in common, tons of illegal immigration, that Bush has either condoned or outright encouraged.
There are four things you don't do during a recession/depression.
1) Dont' start a trade war
2) Don't raise taxes
3) Don't spook business
4) Don't contract the money supply
Hoover and FDR did all four. Obama will do at least 3, possibly 4 if his Great Society on steroids spending leads to massive deficits, to the point that we can't find any more foreigners to finance our debt.
Good times.
there in lies the problem.
It didn't help my confidence that several months ago I moved money from the TDAmeritrade Prime Reserve Fund into the bulletproof (I thought) U.S. Treasury Reserve Fund, and a few weeks ago had seen that money frozen indefinitely -- until today, in fact.
I asked the manager if his bank had exposure to CDOs, and he didn't know. He said he'd check and get back to me. We talked some more. He said the bank was family owned, and didn't leverage their money very much. I am not sure if he's right, but he thinks he's right. He said that the bank had outsourced mortgages and just connected clients with a broker, taking a commission. He said the bank had probably tightened home equity lines of credit, but that for the most part the bank was loaning money as usual for commercial loans secured against assets, and also some regular business loans, which I interpret to mean business lines of credit. He didn't seem to be much focused on a banking crisis, because it appeared to me he didn't have one.
I tell this story, because perhaps the American public is being snookered to some extent about the crisis. On the other hand, I have a friend who was laid off because his company's bank wouldn't make a business loan without micromanaging the firm's cash flow. It sounds as though there is a crisis, but not everywhere.
So far, little or nothing has been done with the $700 billion in the bailout with respect to buying distressed assets. Instead, a number of other measures have been taken which appear to be having a positive impact on liquidity, despite de-leveraging, yen carry trade unwinding, and hedge fund redemptions, that have torpedoed the market over the past week.
So why did we need the $700 billion? I'm a little confused. I though we abso-tively, posolutely needed that money instantaneously, if not sooner, or we'd all be in breadlines by today. Instead, liquidity is being put into the markets in many other ways, and creative solutions are being proposed every day in the financia media.
Some say liquidity has frozen because the banks don't trust each other. When the CDOs are bought up by Mr. Paulson in unknown quantities, from certain (to be announced) banks,which may or may not then have enough solvency for a "going concern," everybody is supposed to have greater trust. I don't think so.
If liquidity is a problem, perhaps Treasury can simply set up a newer, better (and this time, really controlled by the government) Fed with another name, let's say "Bank on US," which we can abbreviate as BUS. If you want an easy ride, just take the BUS.
If any bank wants commercial paper, it just tells the BUS, or the partners of the BUS (see below). The BUS buys the paper and sells it to the bank, keeping a small percentage of the interest payment on the note to underwrite (either self-insuring or through viable firms) "failure to pay" insurance on the borrower. If the BUS doesn't think the paper is sound, it doesn't buy it.
Since this smacks of socialism on a vast scale (although after all, look at the things the Fed has done), we mitigate this by having the BUS outsource its activities to -- say -- the Federal Reserve Banks. The BUS gives them a small cut of its fees to do the screening for asset quality and to put the deals together. In fact, the BUS lets the Federal Reserve Banks do everything in the whole process, and just takes a cut and provides insurance. Sort of like the "mortgage broker" bank I started this comment with. If the Federal Reserve Banks don't have enough liquidity, the "real" Fed loans them money.
But wait. How is that different from the way things used to be? Previously, local banks would borrow from each other or the Fed discount window to put together short-term commercial paper deals. For longer term loans, they would use their own cash with fractional reserves. If they wanted to take on some risk, they could use leverage, although many are now finding that the lever pushes back sometimes.
The new way would put the quality control in the hands of the the entity where the buck stops: the government, or rather its partners, the BUS and the Federal Reserve Banks.
The BUS needs to delegate, because the government doesn't have the resources screen all the commercial paper in the country. Nor would the Federal Reserve Banks have enough resources. So they would outsource to key regional banks, taking a small cut in the process, of course. As a consequence of all this, banks who purport not to have liquidity would get it, albeit for a fee, but would still make profits.
If the banks used their own cash, they could avoid the intermediary fees. Therefore, at an appropriate time of their choosing, when market conditions were favorable, they could divest themselves of toxic assets and keep the resulting cash to lend directly, as they did in the "old days." Or if they prefer, they can keep those MBS/CDO assets and let them generate cash monthly cash flow (or default), or sell them at a discount, or use them as collateral for loans from investors (if anyone will accept them), or try to insure them (if anybody credible to the public is willing to do that) to increase their market value.
How much taxpayer money does the BUS take? None.
The overnight money to buy the initial commercial paper actually comes from the Fed, loaned to the BUS or its partners. Since the Fed has an unlimited balance sheet and we can always print more money (at the risk of debasement of the dollar), there is no liquidity crisis. The BUS, the Fed and the other partners make loans and write insurance for commercial paper. The stalled economic engine should soon restart. It will cough and sputter due to the default of some toxic mortgages, but the wheels of commerce will turn.
The businesses can ride the BUS to commercial loans in order to buy inventory. Their suppliers can get loans to buy raw materials. The manufacturers can get loans for equipment to expand their operations to produce more raw materials. And so forth and so on.
The BUS and its partners can review the loans to ensure that risk is appropriately limited. Although economic growth can be stimulated to over-rev levels through easy credit, with that easy credit comes risk, as we have seen. Far better to limit growth to more moderate levels, so that if credit tightens, businesses have enough liquidity to continue operations without undue distress. This will slow down economic growth, but in the long run, it makes the economy more resilient and mitigates against bubbles, all of which will eventually burst -- it's only a question when and of how far reaching the effects will be. However, it will reduce executive bonuses, so we can't leave the fox watching the hen house. Risk must be reviewed by the lender of last resort.
Some might say, "But wait, we need countless billions of dollars to handle all the commercial loans in the country." This isn't the case. The first commercial loan, when paid to the supplier, puts money in the supplier's bank in the form of cash. That cash can be loaned out at fractional reserve rates. Some of it then gets paid to the manufacturer's bank, where it can be loaned out by that bank at fractional reserve rates.
We leverage our injected liquidity through fractional reserves. Once the credit market unfreezes as normal business practices resume, capital will come back into the banks from the "sidelines." Interest rates for our treasuries should rise somewhat as a consequence, slowing inflation and keeping the dollar stable.
Those latter banks (of the supplier and manufacturer) can use the incoming money (trickling down from the BUS and flowing in from the sidelines) in the same way, buying more commercial paper insured by the BUS for a fee or else loaning money out on their own, without the BUS fee, by making their own judgments about the degree of risk or else buying commercial risk insurance on the loans they make if they can get it at lower rates than the BUS charges.
This is not an original idea, nor is it framed in the same way, but it is similar to the idea being tossed around that the Treasury should simply insure all commercial loans. I disagree with that concept, because it doesn't punish bad judgment. Banks might make unsound loans, because they have no downside if the loans default. In the concept presented above, the judgments of asset quality come from the very parties who are going to provide the liquidity and insurance in the first place and who have a larger stake in the game.
Once the financial pump is running smoothly, with increasing numbers of banks choosing to avoid the BUS fees and just make loans on their own the BUS closes down. Or, another option is to close the Fed down and leave the BUS. But that's another story.