A more true metaphor is that the stimulus will be like a fart in a windstorm. Why? Three reasons: A) It’s small relative to the size of the problem; B) It won’t be spent all at once; and C) It’s programmatic rather than broad-based. The real practical effect of the stimulus bill will be to enable 50 state governors to raise taxes less than they would have been forced to.
Why didn’t Congress take the direct approach and simply enact a payroll-tax cut, which would have ultimately had the same effect, but much more immediate and more salutary? Well, I think the answer to that is more political than economic so I’ll leave it to others.
And coming up fast in the rear-view mirror are the Detroit automakers, who as I’ve relentlessly predicted since December, will soon ask Washington for tens of billions of dollars more. Unless the autoworkers union agrees to far deeper cuts (not likely), the taxpayers will be supporting GM and perhaps Ford Motor, more or less permanently.
But we need to look ahead to the continuing banking crisis. Here we have to make hard choices between who lives and who dies.
Generally speaking, the world’s capital markets are showing not robustness, but at least moderate stability. Anyone who lived through the bizarre disruptions of last autumn will take what we have now and be grateful for it. Credit markets are busily but successfully transitioning to an asset base that is heavily weighted toward risk-free government debt. Stock markets are getting ready for a protracted period of economic weakness all around the world. Stocks will rally sharply from time to time over the next few years, but the overall trend is down.
In this environment, you still have America’s largest banks failing to do what they’re there to do: intermediate the formation of credit for the economy. They’re not making loans, and none of the policy responses to date (a string of ad hoc rescues and a moderate-sized capital injection) has done anything to change that. Neither has policy succeeded in doing anything that would induce any rational private investor to buy stock in a large bank.
The picture among regional and community banks is very different. None of these is lending for much, apart from home mortgages with federal guarantees, but there are many conservatively-run, perfectly solvent banks out there. Part of their problem is an extreme reluctance by regulators to give smaller banks full credit for their capital levels.
But large banks can’t go back to normal lending until their capital levels return to safe ranges. Until then, it’s folly for them even to think about increasing their asset base. It’s a good thing that the people in charge of policy seem to recognize this. We have had some speeches from senior Congressional leaders suggesting that the job of banks is to lend, and by golly, they’ll lend as long as the US taxpayer is their primary shareholder. Such talk would be deeply frightening if it were backed by action, but so far it hasn’t.
Meanwhile, housing prices have not finished falling, and exotic mortgages haven’t finished blowing up inside of mortgage-backed securities the world over. We’re probably at least a full year away from being able to say that the end of asset-price deterioration is in sight. And beyond that, there is still far more housing stock than the US needs. Low housing prices will be with us for the duration of the coming mini-depression.
The Administration is now starting to drop hints about a “Swedish model,” which basically means bank nationalizations followed by re-privatizations in perhaps two years or so.
Such a plan at least has the virtue of recognizing reality. But Sweden in 1994 nationalized almost every single one of its approximately 115 banks. In the US, we have thousands and thousands of banks. Can we possibly nationalize them all? And yet, if we don’t, we won’t really have done anything to instill confidence in their asset books. A partial Swedenization is the best we can do, which means that many regional and small banks won’t benefit.
For large banks, there’s really no question that someone will have to eat the losses they’ve suffered, before some of them can close and others can return to near-normal. This is going to take a lot of time, even if we do everything right. For smaller banks, nationalization is fraught with danger because regulators will always err on the side of caution, yet a lot of those banks really don’t need to be nationalized.
Sticking with large banks, who is going to decide which ones can be left private, which can be nursed back to health, and which should close? It seems to me that Treasury officials are in the best position to do this. If we wait for next quarter’s earnings in early April, the market may signal that none of them are worth saving. The Treasury and the FDIC should be quietly but thoroughly going through the asset bases of all the large banks now. It will take weeks to do this right, and the time to do it is not when a bank is right at the edge of failure.
The real problem with the Swedish approach is the sheer magnitude of the losses, coupled with the fact that we don’t really need as much banking capacity as we swing into depression. Many banks should close, and the Treasury should decide who those will be (and may they choose well).
But it will still take at least $2 trillion in capital, tied up for three to five years, to recapitalize the banking sector. That’s simply inescapable. And only the US taxpayer has a balance sheet that big.
This post also appears at The New Ledger.