Our financial system is crumbling this week.

[Hungary Jack]

Paul Kanjorski, a U.S. Representative from Pennsylania, describes an electronic run on the banks on September 18, 2008, that almost brought down the U.S. economy, and the world economy. His description starts after 2:00 into the video:

[youtube=http://www.youtube.com/watch?v=-xKPcyvl ... re=related][/youtube]

This is the scariest bit of news and damn these people for waiting so long to inform us. I don't understand how all the money disappeared.

Cheney sent all the money to Halliburton in Dubai.

[Hungary Jack]

Paul Kanjorski, a U.S. Representative from Pennsylania, describes an electronic run on the banks on September 18, 2008, that almost brought down the U.S. economy, and the world economy. His description starts after 2:00 into the video:

[youtube=http://www.youtube.com/watch?v=-xKPcyvl ... re=related][/youtube]

I think he's exaggerating just a little there, no?

His explanation of the difference between asset vs. equity purchases misses the point too. The problem is that banks are bankrupt. Buying their bad assets doesn't change that unless you overpay for them (which was probably the idea).

True to an extent, but banks need to know the values of the assets on the Balance Sheet in order to comply with required reserve levels for lending. If the assets on the Balance Sheet are very volatile in value (or impossible to value), it becomes very hard to state your reserves, which makes it hard to borrow more money wholesale to lend at retail, and generally makes bank CEOs become very conservative.

Removing the "bad" assets from banks' balance sheets in theory will alleviate the banks' inability to borrow wholesale and their hesitancy to make more loans.

[Michael]

The whole world feels insane right now.

[Arthur Dent]

The Financial Times' Martin Wolf on the new bank rescue plan:

Why Obama’s new Tarp will fail to rescue the banks

By Martin Wolf

http://www.ft.com/cms/s/0/9ebea1b8-f794 ... ck_check=1

Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much. If he fails to act decisively, the president risks being overwhelmed, like his predecessor. The costs to the US and the world of another failed presidency do not bear contemplating.

What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost. If he does, he can reshape the agenda. Hoping for the best is foolish. He should expect the worst and act accordingly.

Yet hoping for the best is what one sees in the stimulus programme and – so far as I can judge from Tuesday’s sketchy announcement by Tim Geithner, Treasury secretary – also in the new plans for fixing the banking system. I commented on the former last week. 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.

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this “progeny of the troubled asset relief programme” fails, Mr Obama’s credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it.

Continued in spoiler...

[SHOW]

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. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a “no brainer”.

The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why 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.

Assume that the problem is insolvency and the modest market value of US commercial banks (about $400bn) derives from government support (see charts). Assume, too, that it is impossible to raise large amounts of private capital today. Then there has to be recapitalisation in one of the two ways indicated above. Both have disadvantages: government recapitalisation is a bail-out of creditors and involves temporary state administration; debt-for-equity swaps would damage bond markets, insurance companies and pension funds. But the choice is inescapable.

If Mr Geithner or Lawrence Summers, head of the national economic council, were advising the US as a foreign country, they would point this out, brutally. Dominique Strauss-Kahn, IMF managing director, said the same thing, very gently, in Malaysia last Saturday.

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new “good banks”, leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new “bad banks”, leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic.

By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.

[Arthur Dent]

True to an extent, but banks need to know the values of the assets on the Balance Sheet in order to comply with required reserve levels for lending. If the assets on the Balance Sheet are very volatile in value (or impossible to value), it becomes very hard to state your reserves, which makes it hard to borrow more money wholesale to lend at retail, and generally makes bank CEOs become very conservative.

Removing the "bad" assets from banks' balance sheets in theory will alleviate the banks' inability to borrow wholesale and their hesitancy to make more loans.

Given the huge losses in the housing market, many banks are insolvent. The problem then is not that the assets are hard to value, but that if they were honestly valued, banks would be revealed to be broke. Needless to say, broke banks (or banks feared to be broke) have a hard time borrowing money.

Also, see the article above.

[greenback44]

Obama has already responded to a variation of Wolf's argument, albeit extremely weakly:

MORAN: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks?

OBAMA:Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

"Different traditions" sounds like a euphemism for anti-government dogma, or perhaps it's recognition of the everlasting political clout of the financial industry. Obama's been pretty disappointing, and I say that as someone who likely will be unemployed within a few months of the inevitable bank nationalizations.

[ghostrunner]

Obama has already responded to a variation of Wolf's argument, albeit extremely weakly:

MORAN: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks?

OBAMA:Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.

Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country.

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

"Different traditions" sounds like a euphemism for anti-government dogma, or perhaps it's recognition of the everlasting political clout of the financial industry. Obama's been pretty disappointing, and I say that as someone who likely will be unemployed within a few months of the inevitable bank nationalizations.

I think we might be expecting too much. It's more a recognition of the reality before him. He's not a king. Politically, not many people are going to like him coming in and saying "we've got to nationalize the banks right now and if you question it you're signing our death warrant." You can argue he should have pushed harder right out of the gate, and then made his concessions from a better vantage point. But it's a rookie mistake, and he nearly admitted to that in the press conference. He's obviously decided that cooperation across the aisle is a priority for him, and he feels it's important moving into the future. Any attempt on his part to rush things through and make sweeping changes is going to politically cause problems for him later. Not four years from now, but two years. Nothing he does today is going to turn things around by then, and coming out of the gate for nationalizing banks would give ammo to his opposition who are in a pretty good spot to pick up some seats next time. I'm not even sure he could get enough Democratic support for it right now. Even if he succeeded, anything he does could get overturned or significantly changed if he lost the next election.

I think Congress should help shape the debate on this, even if they're wrong. That's part of our system. It seems an odd about-face to me to hear people complain that Obama is giving them too much input after complaining that Bush just did what he wanted, no matter what anyone else thought. That just tells me it's more about whether or not your guy is in office.

I don't see what AD is advocating happening without a serious change of mindset on several levels. I doubt we're close enough to that yet. To get there, I imagine we'll have to take a few more licks.

[Arthur Dent]

I think Congress should help shape the debate on this, even if they're wrong. That's part of our system. It seems an odd about-face to me to hear people complain that Obama is giving them too much input after complaining that Bush just did what he wanted, no matter what anyone else thought. That just tells me it's more about whether or not your guy is in office.

I don't see what AD is advocating happening without a serious change of mindset on several levels. I doubt we're close enough to that yet. To get there, I imagine we'll have to take a few more licks.

To be clear, the Congress thing is Wolf's argument not mine, and I don't think he means it in an our guy/their guy way anyway. As far as I can tell, the arguments against are essentially political and not economic. Right now, that's pretty scary. We're still not taking this seriously enough.

I don't know why nationalizing some banks is so scary anyway. It would undoubtedly be a temporary measure and apply to businesses that seriously screwed up. It's not like we're handing the means of production to the workers' councils.

[Hungary Jack]

I don't know why nationalizing some banks is so scary anyway

Freddie and Fannie essentially were nationalized (their assets had the implicit guarantee of the federal government) and were used as instruments of social policy. That didn't turn out so well.

[greenback44]

I don't know why nationalizing some banks is so scary anyway

Freddie and Fannie essentially were nationalized (their assets had the implicit guarantee of the federal government) and were used as instruments of social policy. That didn't turn out so well.

No, the profits from F and F were under quasi-private control, with losses going ultimately to the taxpayer. That's where AIG, Citi, BoA and friends are now. That's not nationalization. GNMA is under government control, and maybe I've missed some news (I'd appreciate being disabused of this notion), but I haven't heard a peep about problems from it.

Obama's ignored the larger American tradition about flexibility in favor of private markets dogma. As the ABC News interview demonstrates, we're going the route of Japan, even though we know it's stupid. This isn't a rookie mistake, as our fearless leaders are not going into this mess blindly. Taking care of this mess just isn't the highest priority. AD is right, we're not taking this seriously.