[Pen-l] "Has Barack Obama’s presidency already failed?"

[Marvin Gandall <marvgandall@xxxxxxxxxxxx>]

Martin Wolf's column below reflects the widespread exasperation with the new
Obama administration's approach to the banking crisis by financial
journalists, academics, and most any investor who isn't holding much of the
worthless paper of the insolvent big banks or running a vulture fund
lobbying the government for cheap loans and guarantees to pick over the
distressed assets.

Nationalization (by whatever name in deference to the US political culture)
would be widely welcomed. The banks need to be seized and rrestructured and
their books opened and assets managed in the public interest. The dithering
behaviour of the Obama administration is most commonly misdiagnosed by Wolf
and others as "timidity" whereas in fact it is rooted in ideology. The
torturous and complex half-measures involving lavish handouts to failing
banks are recklessly wasteful and desperate attempts to stave off
nationalization, increasingly seen as inevitable by elite opinion, including
on the right.

*    *    *

Why Obama’s new Tarp will fail to rescue the banks
By Martin Wolf
Financial Times
February 10 2009

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.

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.  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.

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