Recently in Banking Crisis Category

Three days ago, the redoubtable Tom Friedman wrote a column in the New York Times which called the stock market bottom in the time-honored manner of big-time journalism: he told us that the sky is falling. The market promptly started an 11% rally, which is going to continue later this morning as I write.

Mr. Friedman wasn't the only one. His Times colleague David Brooks also became alarmed by the fall in his 401(k) account and realized lately that this financial and economic crisis is the real thing. (I should have sent them links to my articles on the subject going back nearly two years now.)

Now that political and cultural commentators have realized they need to weigh in on the economic story, and in a way that considers more than just the evils of income inequality, we also have to deal with their prescriptions for how to handle the situation.

This is a problem because Mr. Friedman, while perceptive about the nature and dimensions of the crisis, reflexively locates the potential solutions in government action. And ultimately in the slender, graceful hands of Barack Obama.

To Friedman, Obama seems distracted by other things and is lacking in needed focus on the economic crisis. (It would be closer to true to say that Obama and his team are simply out of their depth, and flailing.)

But although there is some need for sustained government action, most of this crisis is impervious to what government can do. Government can help to create the conditions for an eventual recovery. But what's going on is something they can't fix.

It would actually be refreshing if someone big and important stood up to say that policymakers really haven't a clue how to improve the economic and banking crises. But no one in a position of political authority is willing to do so, least of all the New Masters of the Universe in Washington. So therefore, the task falls to me.

In the US, there's a growing sense that the Obama Administration just doesn't know what to do about the worsening economic and financial picture. Consumer demand continues to fall, jobs continue to be lost at a rate of more than half a million a month, the credit crisis is still as bad as ever, and housing is still far overpriced.

The bright spot, if it is one, is that Fed Chairman Bernanke has been doing more than anyone else in the world to get ahead of the deepening problems in the capital markets. The leaders of the world's other central banks are mostly watching him and waiting to see if anything works. So far, a lot has worked, but the economic problems that are of greatest concern haven't been touched.

Bernanke's academic specialty has been his studies of the Great Depression, particularly of the dynamics through which a long chain of bank runs and capital-market stresses turned into the worst episode of sustained high unemployment in our history. He also watched closely as Japanese authorities mismanaged their deflationary situation in the early Nineties.

What he concluded is that at a time like this, monetary authorities have to act as fast as possible, and in as much size as possible.

However, he concluded this not because he knows it will work, but rather because nothing else has been known to work. We're in totally uncharted territory, and so far nothing in the broad economy is looking any better.

The essential challenge for America is to simultaneously achieve two things that, in conventional ideology, are incompatible. These are to fulfill society's promise of affordable necessities and comfortable retirement for all, and also to preserve America's culture of freedom and economic opportunity, where anyone can get rich.

To speak of these priorities in these terms is to see how facially incompatible they are. That's simply because ideologues of the right or the left will consider one of the two priorities to be the only one which matters, and the other one will take care of itself.

The mistake that people on the right make is that markets, left fully free, will automatically take care of everyone's material needs, and that government's most valuable contribution will be to get out of the way. On the left, people assume that social justice is a simple matter of redistributing wealth from those who earned it to those who deserve it, and there's more than enough wealth to go around.

So it's perhaps novel to speak of achieving both of these priorities together, given that so many people are so firmly committed to one at the expense of the other. But we stand at a moment in history when it's critical to hold both opposing ideas firmly in mind, to see how they interact, and to see how we can indeed achieve both.

The government is floating the idea of taking up to a 40% share in the common equity of Citigroup, which is about as close as you come to admitting the bank is insolvent.

How are the markets reacting? Government coupon-debt is sharply lower on the news. It's being taken as a positive, reducing the need to hold Treasury paper as a safe haven. Stock markets will climb on the open.

Here's a canary in the coal mine: Canada's CPI has fallen four months in a row, which hasn't happened since the early Thirties. Our CPI is under pressure (it's being held up by slightly higher gasoline prices, as supply ratchets down to meet lower demand), but producer and wholesale prices so far are holding steady. That news is mixed and unconclusive.

There's a remarkable story being reported in the New York Times. It's remarkable in itself, and also because as far as I can tell, it's only being reported in the Times.

It's a proposal by the Treasury for a radical way of restarting private participation in credit markets. I'm only going to give you the barest outlines of this with minimal analysis, because I can't be sure the Treasury really means it.

For many months now, "securitizations" have come to a near-standstill. That's the much-maligned process through which whole mortgages get "sliced and diced" into mortgage-backed securities and sold to the world's investors.

Through a different but analogous process, other kinds of consumer loans are also securitized: car loans, credit cards, and student loans. (The goal is always to give an investor a piece of paper with a credit rating, a semi-annual coupon payment, and a maturity date. Mortgage analytics and risk management are more complicated, but beyond that, the process is the same.)

Securitization matters because banks can't provide credit now that most of them are so far undercapitalized. Securitization is an alternate process through which investor funds are channeled into the consumer credit markets.

It's too early to figure out what Obama actually proposed yesterday, by way of mortgage reforms. It's not even right to call it a proposal, since we're not getting full details for another couple of weeks. It seems like Obama is trying to lead by press release.

There are two aspects to the "plan" that are intended to generate headlines: it will supposedly make mortgage payments "more affordable" for a total of 9 million people; and it will seek to drive everyone's mortgage payment to 31% of their monthly pre-tax income, or less.

Let's quickly dispose of the Fannie Mae/Freddie Mac aspect of the press release. There is a provision of $200 billion to be supplied to the GSEs, for purposes of covering losses in their mortgage portfolios. This would actually be an expansion of the $100 billion that was already provided when the GSEs were nationalized back in September. They haven't yet come near to consuming the $100 billion, so this is less than it appears to be. Still, it's a nice headline.

It's the $75 billion in direct aid to distressed homeowners that's more of interest. So far there are no details on how this will work. Obviously, the taxpayers will be transferring $75 billion to someone. But to whom, exactly?

It seems to me that Obama would like you to think that he's planning to put more money in your pocket. But judging from the uniformly-enthusiastic reactions of banking-industry executives and spokesmen, I think the money trail leads to them rather than to you.

Ok, so the Teacher And Firefighter Job-Preservation Act of 2009 is now law. Last week, President Obama told us that starting today, the stimulus would immediately speed saving succor to the US economy, using metaphors that suggested the stanching of an open wound. Are you feeling stimulated?

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.

Since the beginning of the economic crisis Paul Krugman has been the loudest advocate for a down-the-line, damn-the-torpedoes Keynesian approach. He continues to press this point in his latest op-ed column at the New York Times, which I would link except that it requires a registration.

Krugman knows his economics (and if you forget about that, his Nobel Memorial Prize will remind you). He's been writing cogently and presciently since nearly the beginning of the financial crisis (which long predates the economic one) about the clear and present danger of falling into a deflationary spiral.

Paul Krugman knows how mathematical models work as well as anyone. His problem is that he has a much more pedestrian understanding of how people work. This problem typifies the whole Obama Administration, which pays close attention to Krugman at his perch in Princeton, and professes to revere data rather than ideology.

In his latest column, Krugman cites an analysis by the Congressional Budget Office to the effect that over the next three years, the US economy will underperform its capacity by $2.9 trillion. (Of course, no color on the methodology or the approach of the study, but he's writing an op-ed piece, not an academic paper.) Let's take that large number on faith. It works out to about 7 percent of GDP.

This is the starting point from which Krugman goes on to call for government stimulus spending of about an equal size. Let's deconstruct the thinking a bit.

I just noticed this news story. This is very important. Large employers are now starting to impose large and widespread cuts in wages and salaries.

This is a classic sign of a deflationary spiral, and it's going to be deeply frightening to a lot of people. Especially people in the Administration.

Why? Because sustained deflation is exactly what Obama is talking about when he says that we face the potential for an economic decline that we can't recover from. But there are good reasons to be encouraged by this news.