Bad News

The stock market tumbled more than four percent today in response to the perceived vagueness and inadequacy of the financial bailout program unveiled (sort of) by Treasury Secretary Tim Geithner. The plan has several components:

1) It will set up a public-private fund to mop up to $500 billion of spoiled bank assets.

2) It will set up a consumer-lending facility to support up to $1 trillion in new lending.

3) It will devote up to $50 billion to help stem home foreclosures.

4) It will provide new funding to banks after a “stress test” to determine if the bank is healthy.

An excerpt from Geithner’s presentation today:

The causes of this crisis are many and complex. They accumulated over a long period of time, and they will take time to resolve. Governments and central banks around the world pursued policies that, with the benefit of hindsight, caused a huge global boom in credit, pushed housing prices and financial markets to levels that defied gravity.

Geithner was the head of the Federal Reserve Bank of New York. The “central banks” that “pursued policies”? That was him.

Investors in banks took risks they did not understand.

Indeed. I own 1,000 shares of Citigroup.

Individuals, businesses, and governments borrowed beyond their means.

I didn’t. Most businesses didn’t, either. The biggest borrower was the federal government. But that was nothing: the Obama/Geithner administration proposes to triple, quadruple or more federal borrowing.

The rewards that went to financial executives departed from any realistic appreciation of risk. There were systematic failures in the checks and balances in our system by boards of directors, by credit rating agencies, and by government regulators.

That’s very true. So why, exactly, should we believe that those institutions–the same people, largely–are now going to be able to pull off a trillion-dollar “rescue”?

Geithner warned against timidity, but many economists believe that the program as he (sketchily) described it fails to acknowledge the true depth of the problem. In the Financial Times, Martin Wolf critiques the Obama administration’s approach:

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. …

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the “super-SIV (special investment vehicle)” proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. …

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. … The new plan seems to make sense if and only if the principal problem is illiquidity.

I had lunch today with a prominent economist who made similar observations: a considerable number of banks, including some of the biggest, are insolvent and need to go into bankruptcy. Trying to preserve equity in these institutions is madness.

Howard Fineman was on Hugh Hewitt’s radio show tonight, and made what I thought was an excellent point: the sad thing about the Democrats’ porkfest bill, which President Obama now owns, is how stale and uncreative it is. If only, Fineman lamented, Obama had come up with something imaginative and bold. But no: the bill is just a pastiche of pent-up pork projects.

Wolf says something similar:

I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years’ economic crisis, has let Congress shape the outcome.

[W]hy does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it. …

The one thing we know for sure is that the thirteen-digit cost of TARP II will be borrowed and passed on to our children as part of the most extraordinary deficit spending binge in our history, with consequences that no one can foresee.

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