The new rescue package being put together by Treasury Secretary Timothy F. Geithner is fundamentally flawed. Essentially, it may be viewed as an attempt to defy the laws of financial gravity at a cost of $ 2 trillion. Why is it flawed?

There are two main reasons why it is flawed. The first has to do with how the market for bad debt works, and with two problems with the functioning of this market currently. The second has to do with the stage the crisis of the American economy is in now.

Let’s start by looking at how the market for bad debt works. For the moment it is difficult for banks to unload this debt. The primary reason for this is that the pricing of it is difficult. There is a risk that the value of the debt may deteriorate even further if the crisis deepens. And currently sellers are not willing to sell at a price that reflects that possible downside and want a higher price than buyers are willing to pay.

But why do they not want to sell at the price where the market would clear? In other words, why is the market for bad debt not functioning as it normally does? There are two reasons, I think. The first is government intervention, the second is balance sheets.

The government intervention argument is, simply put, that as long as there is a chance of the government being the first to “chicken out” (due to the political pressures resulting from the crisis) of “the game” of conflicting interests that the crisis also is, there is also a possibility that banks may be able to shore up their balance sheets with government subsidies or capital infusions that allow them to ride out the storm. Thus the debt is worth more to them as sellers – as there is a potential upside in terms of subsidies – than it is to potential buyers lacking this potential upside. So the market will not clear due to a history of government intervention and expectation of more interventions that creates an asymmetric situation. This is perfectly rational.

The balance sheet argument is pretty straightforward too: It is likely that some banks, possibly a lot, are not willing to sell bad debt at market prices because if they do the balance sheets will be red or so bad that it will threaten their survival. And survival is a goal with higher priority than stock price or customer confidence.

So, in essence, these lines of reasoning on the functioning of the market imply that putting in $ 2 trillion to subsidize buyers is government intervention to repair flaws in the market caused by government intervention. Signaling instead that no more intervention is forthcoming would be a significantly cheaper alternative that would have the effect of reducing the sellers’ valuation of the bad debt and increase chances of market clearing. But it would not fix the second problem, the balance sheet problem. To fix the balance sheet problem, government would also need to say that they will go in and shore up banks by, for example, buying stock (possibly at market price).

Morally speaking the $ 2 trillion intervention is pretty problematic too. It is an intervention that allows banks to sell bad debt at a price higher than the current market value. As such it is an indirect subsidy to the banks using taxpayers’ money. Also, the plan is to do this in a fashion where FDIC picks up some of the risk for the buyers of bad debt. And this, of course, represents a direct subsidy of investors – rich people not needing subsidies, and probably not deserving of taxpayers’ money.

And this leads me to the stage of crisis problem. In order to be willing to put up 2 trillion dollars – a fairly big sum – one ought to be extremely certain that the money goes into the economic system at the point where it will be the most effective. And, frankly, for the moment I don’t think this is that point. The crisis started with the credit crunch, but for the moment it is not lack of credit that escalates the crisis. Rather it is lack of demand. The reason banks are not lending, is not that they do not have money to lend, it is that the crisis is still deepening and that they therefore in a lot of cases think it is too risky to lend out their money. More money to the banks will not make them lend significantly more if the crisis continues to deepen – it will only make them richer. Elsewhere, I have argued that redistribution in order to increase effective demand is called for, and I think that is still the case.

So the point where the impact is likely to be the biggest as of now is with stimulating the economy rather than with relieving the problems of the banks. In short – the wealth effect is reversed, times are uncertain, jobs are lost and people are not spending. As well, the crisis internationally means foreign demand is reduced too. So public spending, income redistribution, job creation, reduced taxes and similar measures are likely to have much more positive effects than more subsidies to the banks.

So, concluding, I think there is every reason to discuss and most likely rethink the so called TARP 2.0. I think it is very likely that it is not the most effective possible policy measure, and I also think it is wrong morally speaking. There has been too much subsidizing already – it should end.

©2012 nekkidblogger. All Rights Reserved.

It is popular right now to blame banks for the financial crisis – that is, the current recession in the US. The banking system in the US is not working, people say. Banks are not lending, not passing the government billions on to hungry borrowers. And so on.

The hidden premises behind these lines of reasoning are two. One is that banks ought to be lending more money to borrowers than they do (especially since they have received government bailouts). The other is that the economic system is not working because banks are not lending as they are supposed to. Both premises are seriously flawed.

Banks in the US are currently doing exactly what they should be doing. Look at it this way: You are a banker. For the last several quarters you have had huge losses. So have other banks. Furthermore, the economy is bad. You think housing prices may fall another 20 percent, that GDP may drop another 10 percent, that 5 million more may become unemployed. As well, you expect Dow to drop to 5500. And as lots of other banks are losing money big time, you want to be cautious about borrowing to them as well. Also you read every day about businesses losing money or making considerably less money than before. As well, you know the same thing is happening in Latin America, Europe and the Far East. And commercial real estate is in a decline, and default on credit card debt is rising.

Who would you lend money to? Or – more generally – is this a climate where you would want to lend at all? I think maybe not. I certainly would not if it was my money.

So, in a situation where the economy is still on the way down – and pretty fast as well – the banks are doing the right thing! They are behaving in a rational fashion as far as lending is concerned.

So, if you want to blame anybody – blame the financial institutions for the crisis, and the Bush-administration for giving away money to the financial industry without imposing sufficiently strict terms. But not the banks for not lending right now!

The second premise is equally flawed. Why it is, should be apparent. Simply because the problem is the economy itself, not the banks. It is not that the economy is dropping deeper into recession because banks are not lending, but rather (or more correctly “more”) that banks are not lending because the crisis is still expanding, spreading and deepening. Thus there are few solid, good borrowers around.

Thus the primary task right now is to shore up the economy and make it work again. Forcing banks to lend would be wrong – it would lead to even greater future losses, as the risks currently are simply huge! This is probably true not only for the US, but many other countries as well.

See also: Times: Obama prepares to unveil plan to rescue US banking industry from $2 trillion hole

©2012 nekkidblogger. All Rights Reserved.

Are Americans blind, deaf, and averse to logic? The US wants to move the economy out of the recession by spending. But the US is broke! So, where is the astute, logical, realist analysis of the real situation of the US – as opposed to the emotional, imagined, desired situation of the talking heads – in all of this? America lives in the past, and refuses to see the present!

• Now, the US has a debt amounting to 355% of GDP. As New York Times writes today: “This is a crisis of excessive debt, which reached 355 percent of American gross domestic product … It cannot be solved with more debt.”If you ponder that number, it means that at an interest rate of 5%, the US will be spending about 17.5 percent of GDP just to pay interests on its debt. One sixth of everything produced in the US, that is. Every sixth house, every sixth car, every sixth Microsoft Office program!
• As well, the economy is shrinking fast. Which that means that in the near term, the GDP-base for paying those interests will be smaller, and the proportion higher.
• Also, every economic indicator is pointing down – consumer spending, house sales, industrial orders, unemployment, corporate earnings, you name it.
• And, the US will get very little assistance from increased demand in overseas markets. The economies of US’ major trade partners are heading in the same direction. Demand is shrinking rather than expanding.

This is the real situation (New York Times):

With inventory accumulation gone, the economy will contract in the first quarter at more than a 5 percent annual rate, Mr. Gault said.

Employers reduced their corporate investments in computers, office equipment, machinery and other capital goods by an annualized 19.1 percent in the fourth quarter.

Trade fell, as Americans bought fewer Asian-made televisions and computers, and global demand for American goods and services ebbed. Exports in the fourth quarter declined 19.7 percent while imports dropped 15.7 percent.

And now, in this situation – with the US now, as opposed to in it glorious past, being in reality a relatively poor country that has borrowed much too much in the past – the US is planning to spend more billions of dollars to speed up the recovery from the crisis. If this spending is to be considered as an investment, when will it be recovered? What is the probability that an investment of one extra trillion will be recovered any time during the next 10 years? Very, very small, I think.

America and Americans are impatient. They want things to happen fast. They want a quick fix when things go wrong. And they want it, even demand it, yesterday. Somehow I think the quick fix of this crisis simply isn’t there. And I think hard work and patience is called for. The only card left to play for the US currently, I think, is to redistribute wealth in order to increase consumer demand. Part of that is actually to let businesses fail, so that shareholders and owners lose money. Not to shore up failures in a vain hope that they will some day, hopefully, recover.

See also: Citibank – let it roll

©2012 nekkidblogger. All Rights Reserved.

Barack Obama is faced with a monumental task: Rebuilding the US. Really, I think that is what it amounts to. Rebuilding and reasserting the core values of the nation – placing once more the values of freedom, dignity, and human rights back into everything the government is involved in, in the US as well as internationally. But also rebuilding an American economy moving increasingly, in more and more sectors, into a deep recession. It is this second part I address here.

It is possible to spend enormous amounts of time and paper to ponder and write about what went wrong. And every day more is produced on this topic. In the past, I have participated in this as well. And indeed, it is important to learn about the causes of the recent demise of the US and world economies. Yet the most important thing to discuss right now is, even so, how to rebuild, not why there is a need for rebuilding.

To my mind, a prominent and highly important feature, and probably the biggest challenge, is lacking consumer demand. For sure, there are others as well, such as rebuilding confidence, making the banking system work again, and so on. However, to me these are secondary factors in the current crisis as well as factors that are hard to influence.

Consumers simply are not spending enough to reverse the decline, that is a crux to understanding how to rebuild. For obvious and rational reasons that need not even be repeated, apart from noticing that a reversal of the wealth effect due to falling housing prices plays a key part, consumer chose not to spend. And this is important, as the housing market in the US may be expected to take a long time to recover – perhaps even a decade. Thus there will be no positive contribution to consumer spending from increased wealth for years to come.

The only way to increase consumer spending currently as far as I can see, is to redistribute. There are sound and compelling reasons to do this. Simply put, a set of policies that redistribute wealth and income to the lower income groups will increase spending due to differential propensities to consume, as J. M. Keynes used to call it, in different income groups. Or, stated differently: Since lower income groups tend to spend a higher proportion of their income, redistribution will increase effective consumer demand.

So to me, and leaving all political preferences for or against income and wealth equality, equity, social political philosophies and such aside – there is a strong case to be made, from an macro economical point of view, for redistribution as a cornerstone in a policy to rebuild America. (I also think future research may well point to the growing inequality, resulting in more and more money being spent for speculative purposes in recent years as a contributing factor to the current crisis.)

Also, while I notice that “talking heads”, industry paid commentators, as well as well meaning opinionated folks all the time voice the opinion that the current crisis will be over in a quarter or so, and have been doing that for the last six months, I think all the evidence points in the direction of a deep and long recession. Given this, the advantage of some types of redistribution policies, e.g. tax cuts for low income brackets, is that they work fast – much faster, for instance, than public spending programs or public works. Tax cuts for businesses, which the Republicans seem to want, on the other hand, are likely to have no impact or at best an insignificant short term impact in the current situation.

So to me, in the current situation, redistribution ought to be used extensively as an instrument to stem the tide of falling demand. There are many other jobs needing to be done, for sure. But this is one of them, and one of the more important ones as well. And it seems very likely, also, that this will one of the approaches employed by the new Obama administraton.

©2012 nekkidblogger. All Rights Reserved.