Sooner or Later Revisited

I wrote on February 13^th that if you know and I know that sooner or later, the government is simply going to have to be more direct in getting the credit markets unfrozen, why isn’t the government doing that? The February 18^th theDeal.com reported that the money “invested” in banks under the TARP bailout has barely created a mild ripple in the consumer and business debt markets. And until those credit markets are unfrozen, the only new jobs we are likely to see are those directly created by the American Recovery and Reinvestment Act… a program that will take years to begin to make a difference in the unemployment rate. Why don’t the government folks get it?!

The old way of getting credit flowing – banks selling off their loans in “securitized” bundles to third parties, freeing up the bank to lend more money – is dead. Those bundles (derivatives) tanked and brought down the balance sheet of the buyers, who now not only have devalued paper on their books but no money to buy any more bundles of bank loans. The February 20^th New York Times: “The result has been a drastic contraction of the amount of credit available throughout the economy. By one estimate, as much as $1.9 trillion of lending capacity — the rough equivalent of half of all the money borrowed by businesses and consumers in 2007, before the recession struck — has been sucked out of the system.”

Bottom line, and it isn’t going to be cheap, the government has to pour the money they want to see in the lending markets to save jobs directly into the lenders themselves. The remaining $350 billion of TARP money isn’t going to cut it; we probably need to start with two to three times that amount. And the longer we wait, the more money it is going to take to fix the system.

Right now, the government is trying to figure out how to “stimulate” private investors into feeding the banks who feed the credit markets by guaranteeing such private investors against losses. Investors effectively would have somewhere between 5-16% of the total risk, depending on the loan and the deal with the government, and the government would pick up the rest. Again, we see an indirect effort, but so far, all of these indirect methods have fallen incredibly short. Investors are just plain scared; they’d rather sit on their cash than take any risk. The likelihood is that money put into this indirect program will just be one more government write-off. Sooner or later, it will be the government that is directly funding the loans themselves or we simply slide into a full blown depression.

Estimates presented in my earlier blog suggest that the number that needs to be placed into the banking system – by the government – specifically for the purpose of being loaned out into the commercial debt markets is on the order of between $500 billion to as much as $2 trillion. It seems inevitable that at least some of these clearly failing banking behemoths are going to have to be taken over by the government – the new “n” word (“nationalization”) – until they are healthy enough to be spun back into the free marketplace again. As noted in a recent blog, the mere fact that the government is unconcerned about the impact of their salary caps on these larger institutions seems to suggest that some increasing role of government administration and control is the current clear direction.

But if you want an even clearer signal, from the prince of laissez faire, former Federal Reserve Chairman Alan Greenspan, note how he is now contradicting his long-held policies by now advocating the possibility of nationalizing a few banks. From a recent interview in the Financial Times: “It may be necessary to temporarily nationalize some banks in order to facilitate a swift and orderly restructuring… I understand that once in a hundred years this is what you do.” Even Republicans like South Carolina Senator, Lindsey Graham, are willing to accept what is probably inevitable (from the Financial Times as quoted in the February 18^th theDeal.com): “We should be focusing on what works. We cannot keep pouring good money after bad. If nationalization is what works, then we should do it.”

Japan had a nasty recession, resulting from its own burst real estate bubble in the late 1980s, that literally consumed the entire 1990s with failed infrastructure and other comparable stimulus packages, until the Japanese government finally (and successfully) intervened, in the early part of this decade, and provided the needed capital injections. Sweden saw the wisdom of such intervention in 1992 with positive results. Even the U.S., in the late 1980s, had to step in and save the failed savings and loan business (the “thrifts”) from their real estate excess by putting the nasty loans and sorry foreclosures into the government-controlled Resolution Trust Company before slowly releasing these assets back into the marketplace.

We need credit; banks don’t want to lend but are happy to take bad assets off their books any way they can. They are busy deleveraging, focusing on their survival and not the betterment of our economy in general. Their priorities, further limited by the strict regulation by bank examiners, are not the policies of our highest elected officials or what is best for the nation as a whole. Private investors are looking at falling stocks, falling home prices and rising unemployment; they aren’t going to be easily “stimulated” to unfreeze credit and help fund banks to make loans in a world of declining values and eroding earning power!

I’m getting pretty fed up with the “indirect” approach; if you are going to spend taxpayer money to create a very necessary effect, particularly after a significant period of clear failure with the indirect approach, it’s time to bite the bullet and put the money you want in the credit markets directly into the distributors of money – the banks themselves – for the sole purpose of lending! If the best way to effect that policy is nationalization, the sooner we implement that policy, the less damage we will have to repair! If we do not unfreeze the credit markets, there is no way on heaven or earth to turn this economy around!

I’m Peter Dekom, and I approve this message.