This Will Cheer You Up

Well, actually, it won’t. If the writer of this piece is correct, the Obama administration is in for a rough ride. Unfortunately, that rough ride will take all of America and a goodly chunk of the world along.

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 stock markets tanked on the announcement of the latest plan to bail banks out. That does not bode well for hoping for change. If the author is correct, the hope for the best strategy is not going to work out at all. We’ll be left with a bunch of propped up zombie banks. And the global economy will tank. If the banks are, in fact, insolvent, the plan announced today will only briefly stave off a real collapse.

Houston, we have a problem.

No Great Victory

Well, if the latest poll is to be believed, Obama “won” and got his “stimulus” plan passed. But he lost something along the way: the voters.

Overall, 53 percent of Americans agree that the Obama stimulus bill will actually hinder economic recovery; while only 31 percent disagree (16 percent are not sure). Fifty-six percent of Independent voters also agree, while only 27 percent disagree (17 percent are not sure). A staggering 88 percent of Republicans agree and just 6 percent disagree (another 6 percent are not sure)……

……Sixty-six percent of Independent voters think Obama wants to spend too much money on items that won’t improve the economy. As for Republicans, a staggering 93 percent agree.

Across the board, the poll found that, on average, 90 percent of Republicans and 60 percent of Independents disapprove of Obama’s stimulus bill.

Obama’s supporters will, of course, disregard the Republican numbers. They ignore the independents at their peril. These are disastrous numbers. If Obama loses the independents, he’ll be a one term wonder, just like Carter. And this “victory” is doing a lot to lose those voters. They’ll be much harder to win back if the bill does not help. (Which I, frankly, do not believe it will – or can.)