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Wednesday, February 25, 2009

faith-based initiatives

I was glad to see Paul Krugman was also baffled by plans to possibly convert preferred shares in ailing banks into regular equity capital, as if it was some big deal, successfully making me feel less stupid for a half hour. Compared with equity, interest-bearing preferred shares give banks an incentive to rush to pay back the government when we'd much rather have them lending, potentially numbing the effect of aid, maybe.
It’s true that preferred stock has some debt-like qualities — there are required dividend payments, etc.. But does anyone think that the reason banks are crippled is that they are tied down by their obligations to preferred stockholders, as opposed to having too much plain vanilla debt?
The biggest problem of course remains on the asset side, where Treasury officials are still working through the details of a plan to encourage private investment in the toxic assets, a week after Tim Geithner's supposed 'big bang' financial rescue. I'm sure he's a bright enough guy but I'm struggling to understand how everyone is supposed to keep swallowing news like this...
One reason US authorities are reluctant to pull the plug on any big banks is that they hope their toxic asset purchase plan could show that losses on traded assets may not be as large as they feared.
...when at the same time they're arguing this...
Second, the authorities said all the big US banks were solvent. “The major US banking institutions have capital in excess of the amount required to be considered well capitalised.”

The authorities are emphasising that the stress test is intended to determine how much additional capital each bank might need if the economy turns out to be even worse than expected.
If you merely hope these assets are actually worth more than they appear, you can't simultaneously argue that these banks are solvent with any certainty.

More revealingly, the stress tests for US banks that began yesterday it turns out project a worst-case scenario of US unemployment at 10.3%. This is high, but not outlandish, and higher is certainly not out of the question since employment has lagged even in recent periods of growth compared with earlier, and especially since we're facing a genuinely global recession. In previous recessions there was a motor running somewhere, but that is not the case now. Everything is contracting. The numbers from Asia are particularly frightening. Given this outlook, assuming a baseline worse-case of 10.3% seems insane.

Even more amazing are the stress test assumptions for house price falls. Krugman again:
They consider a fall of housing prices, as measured by the Case-Shiller 10-city index, of 27 percent from 4th-quarter 2008 levels to be as bad as it could get. But the CS-10 were around 30 percent overvalued relative to rents or overall consumer prices in 2008 Q4 — so their worst case is for housing prices to fall to historical norms, with no overshooting.
This is effectively saying house prices are more or less done falling and will not overshoot on the way down. For a supposed "stress test" this absolutely beggars belief.

A few days ago I was willing to bet the Treasury and Fed were merely buying time until the stress tests could reveal that the weakest banks were fucked and that drastic action was warranted. But the aggregate here seems to indicate a continuation of the same:
  • hoping investors will buy toxic assets...
  • that are hopefully worth more than everyone thinks they are...
  • so banks are hopefully not insolvent...
  • so hopefully we wont have to keep giving them money...
  • which is what we will continue to do in the interim.
In other words, the same damn thing we've been doing for 18 months. The only real effort seems to come from avoiding nationalization at all costs. The rest is a faith-based initiative.

Praying is for churches, dickheads.

1 comment:

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