Neel Kashkari Is the Banks' Zombie Master

There were three theories about what made the Great Depression great, and how it could have been avoided by better policy.

• Milton Friedman: the Depression was Great because of a lack of liquidity, and if only the Federal Reserve had kept the money stock from falling everything would have been fine.
• DeLong-Summers: the Depression was Great because expectations of continued deflation became entrenched, and when those expectations were broken--by Roosevelt's New Deal--recovery began.
• Ben Bernanke: the Depression was Great because of the collapse of the banking system, and the resulting credit channel failures that robbed businesses seeking to expand of capital.

The past fifteen months have been a big strike against Friedman: Ben Bernanke has kept the economy liquid, and yet we are in a recession which may become a deep recession. The past fifteen months have been a strike against DeLong and Summers: no expectations of deflation have emerged, and yet here we are.

Bernanke's theory of the Depression is the only one standing (which doesn't mean that it is right, only that it may be right).

So what to do? We don't want to let the banking sector collapse into bankruptcy--Lehman Brothers was bad enough, and we don't want to replicate the Great Depression. But we also don't want to repeat Japan's mistakes of the 1990s, with zombie banks neither alive nor dead failing to do their job for the economy as they focused on getting back above water to create some value for shareholders and executives.

And here is my worry about the current plan to buy preferred rather than common stock of the banks. Preferred stock runs a risk of creating zombies -- if shareholders and executives conclude that the preferred has all the equity value if they continue business as usual, then they will not continue business as usual but will instead start behaving like the Japanese banks of the 1990s. And we don't want that.

By mighty spells the Head Voodoo Priest Henry Paulson has raised the corpses of America's biggest banks from the graves to which the financial crisis was consigning them, but has he restored them to life, or just to zombiehood? Will they do their job for the economy, or will they begin wreaking destruction, all the while crying out: "BBRRAAIINNS! BBRRAAIINNSS!"

If so, it will be up to Neel "The Zombie Master" Kashkari to control them...

Comments

[InnocentsAb...:]

Gee -- if the money center banks and the left-behind investment banks are zombies, wouldn't it be more efficient just to put the money directly into the bond market by buying senior debt at the current market discounts ?

I suppose, once the fix is in, the debt discounts will disappear (or relatively so)

2008 Oct 14 11:58 PM

[John Lounsbury:]

The DeLong-Summers theory may have one strike against it but there are three strikes for an out, three outs for an inning and nine innings in a game. Don't jump to any conclusions about the outcome of the game after the first strike.

2008 Oct 15 12:36 PM