[Op/Ed] Why Obama's plan will fail

[J]

Financial Times link

Why Obama’s new Tarp will fail to rescue the banks
By Martin Wolf
Published: February 10 2009 18:06 | Last updated: February 10 2009 18:06


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 (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.

Finally, another person who "gets it". My opinion on this subject has been stated many times already, it's time to admit we have a very serious problem with no possible quick fixes, and get the adults back into the room to start fixing it. We need to come clean and take our medicine, no matter how bad it tastes.

[ray245]

The problem is, can the situation in 2012 be better because of such a plan? The last thing we need is the Republicans coming into power in 2012.

[GrandMasterTerwynn]

The problem is, can the situation in 2012 be better because of such a plan? The last thing we need is the Republicans coming into power in 2012.

Yes. Decisive action now will lead to merely a deep recession followed by economic recovery in less than a decade. Being sucked into, what is fundamentally, inaction by centrist pole-polishing will, at best, result in decades of stagflation. At worst, to paraphrase Jeremy Clarkson, I can see a day where I will have to shoot some of my neighbors as we fight over the last can of Campbell's chicken noodle soup at the burnt-out ruins of the local Wal-Mart. Unfortunately, so far, the Obama Administration has shown an alarming adherence to the classic Democrat strategy of "bend over to the Republicans and hope for a reach-around in the name of 'bipartisanship'."

[Illuminatus Primus]

Why is everyone pretending this isn't more serious and there cannot be an 18 month turn around to wonderful times?

[aerius]

Because they own unicorns which shit out solid gold bars?
Damned if I know why, I ain't psychic.

[Guardsman Bass]

Well, look at how well TARP ended up looking like the original "plan" (if you can call it that) by Paulson when he asked for the $700 billion TARP funds. Geithner (and Obama) are under a considerable amount of pressure to get something out there in terms of a financial sector reform, and I wouldn't be surprised if the final form of that looks much different than what Geithner is proposing now.

[The Jester]

Is it possible that the models they're using for the economy are simply flawed? Looking at Dr. Stephen Keen's posts on the Australian economy on his blog at DebtWatch he makes a point that Australian economists use a flawed model and there seems to be a lot of ignorance amongst economists over differential equations.

Economists, even non-orthodox ones, simply aren’t accustomed to thinking dynamically, and normally lack any exposure to the sophisticated tools that engineers in particular use routinely today.

[Mayabird]

Because most people don't relish the thought of being utterly hopelessly fucked when they know there's nothing they can do to avoid it and nothing they could do to rescue themselves if it happened, so all they can do is hope for the best because if/when it all collapses they'll end up in the exact same situation anyway, which is starving in a shantytown at best or maybe dead.

[Darth Wong]

The elephant in the room is that people have different notions of success or failure. Most of the American people believe that "success" means that the country will magically return to the prosperity levels it enjoyed at the height of the bubble, even though those prosperity levels were a result of a Big Lie that finally imploded. More clear-eyed observers believe that "success" means that we manage the shrinkage of the economy more rational levels in such a manner that human suffering is minimized.

Unfortunately, the prevalence of the former (idiotic) view means that Obama will almost certainly be viewed to fail in this endeavour, and quite frankly the Democratic party should be working overtime to make sure people remember to put the blame for this on the Bush Administration.

[ray245]

The elephant in the room is that people have different notions of success or failure. Most of the American people believe that "success" means that the country will magically return to the prosperity levels it enjoyed at the height of the bubble, even though those prosperity levels were a result of a Big Lie that finally imploded. More clear-eyed observers believe that "success" means that we manage the shrinkage of the economy more rational levels in such a manner that human suffering is minimized.

Unfortunately, the prevalence of the former (idiotic) view means that Obama will almost certainly be viewed to fail in this endeavour, and quite frankly the Democratic party should be working overtime to make sure people remember to put the blame for this on the Bush Administration.

The problem is, the Republicans will now try and make it hard for any future bill to pass in the Senate. The 3 Republicans that supported the bill might be unwillingly to support the Obama administration next time.

[Illuminatus Primus]

Because most people don't relish the thought of being utterly hopelessly fucked when they know there's nothing they can do to avoid it and nothing they could do to rescue themselves if it happened, so all they can do is hope for the best because if/when it all collapses they'll end up in the exact same situation anyway, which is starving in a shantytown at best or maybe dead.

Well there's a big difference from tough times that require hard work, novel thinking, and major change and reform and utter collapse.

[Darth Wong]

We have to stop thinking that we are either irrationally prosperous on borrowed money or we are "fucked". There is a middle ground, and we need to accept that and try to chart a course for it.

[Starglider]

Why is everyone pretending this isn't more serious and there cannot be an 18 month turn around to wonderful times?

Sentiment does matter. Remember how much Alistair Darling (the UK chancellor) was slammed when he admitted that 'we are facing the greatest financial financial crisis since WW2' in the middle of last year. Unfortunately many decision makers don't seem to realise that sentiment matters less than fixing serious structural problems.

[Kanastrous]

Why is everyone pretending this isn't more serious and there cannot be an 18 month turn around to wonderful times?

Maybe there's a fear that people in general will panic and do things that worsen the situation, once they admit to themselves how serious the situation has become.

[The Duchess of Zeon]

The elephant in the room is that people have different notions of success or failure. Most of the American people believe that "success" means that the country will magically return to the prosperity levels it enjoyed at the height of the bubble, even though those prosperity levels were a result of a Big Lie that finally imploded. More clear-eyed observers believe that "success" means that we manage the shrinkage of the economy more rational levels in such a manner that human suffering is minimized.

Unfortunately, the prevalence of the former (idiotic) view means that Obama will almost certainly be viewed to fail in this endeavour, and quite frankly the Democratic party should be working overtime to make sure people remember to put the blame for this on the Bush Administration.

Success right now is that our economy recovers enough in the next three years that we can spend the next decade and a half after that emulating Japan during the 1990s. America's Lost Decade will necessarily be more or less a Lost Generation of neigh-on twenty years due to the fact that our economy tanking like that and then never really recovering will have a much more severe effect on the rest of the world than Japan's did, making the stagnant ground after the collapse last even longer.

Think of the positive side, however!

Emissions contributing to global warming and the consumption of nonrenewable fossil fuels in the world has plumeted. The longer the dead zone lasts, the longer we're going to have before we run out, and the better the chance that someone will come along due to the economic crisis who is decisive and autocratic enough to force through the necessary development to help us out. The total collapse of the world economic system, while leading to widespread misery to be sure, may actually save hundreds of millions of lives. This is like manna from heaven for those of us who were afraid of peak oil--there's a reason I've stopped bothering to speak on the subject in the past months. It's because this collapse having thrown a wrench into the machine of world finance and all of the consumption that's gone with it is literally exactly what we needed to be given an extended and sustained chance to avoid the worst-case scenarios.

[Kanastrous]

The longer the dead zone lasts, the longer we're going to have before we run out, and the better the chance that someone will come along due to the economic crisis who is decisive and autocratic enough to force through the necessary development to help us out.

Let's hope that's *all* they choose to force through, while they're being all decisive and autocratic...

[The Duchess of Zeon]

The longer the dead zone lasts, the longer we're going to have before we run out, and the better the chance that someone will come along due to the economic crisis who is decisive and autocratic enough to force through the necessary development to help us out.

Let's hope that's *all* they choose to force through, while they're being all decisive and autocratic...

FDR was extremely autocratic, to the point of packing the US Supreme Court, so I'm not suggesting a dictator here.

[weemadando]

I'm still very pissed that so many people are trying to ignore how bad the situation is and going out of their way to extend the good times (read bailouts) at the cost of creating a longer "bad time" in the future.

How could anyone have been convinced that giving 800 billion to the people who fucked it all up would in any way fix it?

There's just so many things wrong with this. And the worst thing for Australia? The gov'ts continue to make it more and more appealing to be on welfare as opposed to working so our tax base will continue to be hit for a long time after this crisis as people who became unemployed choose to continue with welfare rather than go back to work.

Add to this the fact that everyone wants to believe that the problem can't be that bad and won't affect them and Australia might be dodging a bullet for the moment, but we're going to be hit just as hard (possibly harder if minerals trade keeps plummeting) and for longer than a great many other countries.

[aerius]

...and quite frankly the Democratic party should be working overtime to make sure people remember to put the blame for this on the Bush Administration.

Obama had a golden opportunity to come clean and tell the nation the bad news of where we are and what's to come, and more importantly, put the blame for everything squarely on the Bush administration and the Republicans. He has the oratory skills, charisma, and popular support to do that, but he didn't, and every day that passes and every mistake he makes takes away from the support & charisma until eventually the public sees him as just another lying politician. And when that happens he won't have the power and support to do what needs to be done even if he wanted to.

In the week or so following the inaugaration he could've said something like America, we are in deep shit thanks to the BS of the previous administration. I have to be honest with you, we all face a great challenge and hard times ahead of us, and there are no quick or easy fixes. But with hard work and sacrifice we can get through this, my advisors have drawn up a plan for the future, to build a better America for ourselves and our children. This is this is where we are, and this is what we need to do... and the people would've eaten it up and followed him into hell. Obama still has a chance to man up and do that, but not for much longer.

[Chris OFarrell]

You know, its human nature to deny bad news, but is it just me or does a lot of the population of the US take it to an art form?

Global warming, denied for years, then fought tooth and nail over if its going to be bad, or agreeing that its going to be bad but its not humans doing it OR its too late, anything to give up something. Death, if some of the recent threads on healthcare is any indication, is just some sickness the doctors can treat like cancer, which one day they will find a cure for. Peak Oil? The oil companies say we're fine, just those damn dirty arabs not giving AMERICA the Oil AMERICA deserves! ANWAR! Rar! Financial meltdown? Nah we can roll with it, just keep pumping cash in and it'll all be fine! The grandkids can pay it off!

Sure I know other countries have similar problems to lesser and greater extents...but the US really appears to take it to an artform at some times.

[KrauserKrauser]

Didn't he basically say the same thing already? From the campaign trail to the inauguration, those were the types of words he was using, so obviously his words don't mean jack shit if this stimulus bill is the best he can come up with.

[General Zod]

In the week or so following the inaugaration he could've said something like America, we are in deep shit thanks to the BS of the previous administration. I have to be honest with you, we all face a great challenge and hard times ahead of us, and there are no quick or easy fixes. But with hard work and sacrifice we can get through this, my advisors have drawn up a plan for the future, to build a better America for ourselves and our children. This is this is where we are, and this is what we need to do... and the people would've eaten it up and followed him into hell. Obama still has a chance to man up and do that, but not for much longer.

Uhhh. . ., I'm pretty sure he's said something very similar already.

[aerius]

Uhhh. . ., I'm pretty sure he's said something very similar already.

Too bad he didn't tell the truth, which is "the financial system is insolvent and it need to be crammed down right fucking now, and these assholes are going to fucking jail". Implement Genesis plan, fully fund FDIC and social services, and nukes for everyone.

Did we get that? No. We got more of the same crap, but with prettier words.

[Nova Andromeda]

-This is very well written article for the average semi-informed person and thanks for posting it J.

-The question for the rest of us is what to do about it?
1. Write, call, pester your representatives (daily/weekly). Send them this article, tell them they, their children, and grandchildren will pay for the mistakes they are making and they need to fix it NOW. It's FAR past time to play politics as usual. In fact, the more informed of us should help write a good letter for us to send. How about this to start:

Dear (Rep./Sen./etc.) ___,

* been following the economic crisis and our government's response to it with growing shock and concern
* as so well described by Martin Wolf (link to article or just quote the thing below??) we face a crises of historic insolvency
* it is not a problem of liquidity (or at best liquidity is just a symptom)
* large parts of our financial system are bankrupt: size = 2.2 trillion (link to IMF?)
* the bankers complete lack of ethics is what created this crisis in the first and it should be no surprise they will say ANYTHING to convince you to save their bacon no matter the cost to the average American

* a system of capitalism combined with socialized risk (bailouts) is even worse than outright communism (might as well capitalize ... hurr hurr ... on their fears)
* it is the worst king of moral hazard to bail out private entities that made bad bets
* the average American gained nothing from the boom times while the bankers, etc. that are being bailed out grew richer than kings

* we cannot afford to play politics, you must stand up and fight for the correct actions
* I, and my friends, family, etc. will support you in that fight
* history and your children and grandchildren will judge the actions you take now, ignorance and politics will be no defense

-Closing:
* America must take it's medicine, the good times are gone for now
* YOU will pay politically when your current plan fails AND personally when the world economy fails to recover!
* You MUST slay the Zombie banks NOW or at least stop feeding them
* illiquidty can be solved by setting up an alternative lending system (whether that is a national bank, capitalizing local banks, etc. I leave to you)
* this MUST be done NOW before all economic activity grinds to a complete hult and cannot be started again
* Please contact ____(need good informed ppl to send them to) for further information on ____(stuff addressed above) or me personally if you need help in this difficult time.

Sincerely,
_________

Find your representative.


2. If we assume the worst happens and our government fails to fix this mess, what should the average person do? What countries will be the least impacted and still livable (Saudi Arabia is not livable). Which jobs will be the most stable (medical, science, engineering, probably not anything related to luxeries?). What oportunities are there (are houses a good buy? how about stocks? which ones?).


3. Science could use a lot more funding and considering the size of the stimulus package I encourage everyone here to pester their representatives to support the following (and reinstate the National Science Foundation's funding):

Push for $10 Billion for NIH in Recovery Plan Act Now

Keep up the pressure on Congress to include $10 billion for NIH in the
American Recovery and Reinvestment Act. Thanks to a strong show of
support from research advocates and leadership from Senators Specter,
Harkin and Durbin, the Senate approved an amendment to increase the NIH
allocation from $3.5 billion to $10 billion. As Senate and House
leadership reconcile the bills, urge your members to reinforce their
support for research as a critical economic driver in communities
across America.

Call your representative and senators to let them know you want $10
billion for NIH included in the final version of the bill. Find your
members' phone numbers at
http://capwiz.com/ram/utr/1/NRVGJTZJRH/ ... 903371261/ and use the talking points below.

The funding for NIH will:

* provide short-term economic stimulus by creating 70,000 jobs;
* more than double each dollar invested in economic output;
* boost the economy of every state because 90% of NIH funding is
distributed to colleges, universities and research institutions across
the country;
* help the U.S. remain competitive globally in research and innovation;
* allow Americans to live longer, healthier, more productive lives and
* reduce health care costs through more effective prevention and treatment.

Tell your delegation that investing NIH now will pay off in the short-
and long-term. The best way to contact your members is by calling, but
you can also send them an e-mail by going to
http://capwiz.com/ram/utr/1/NRVGJTZJRH/ ... 2903371261. Take action now!
---


Ellen R. Weiss
Director of Policy & Communications
Biophysical Society
301-634-7176 (phone)
301-634-7133 (fax)
eweiss@biophysics.org

[Darth Wong]

You know, its human nature to deny bad news, but is it just me or does a lot of the population of the US take it to an art form?

Dude, there are plenty of Americans who still deny that second-hand cigarette smoke is bad for you. "Head in sand" seems to be a preferred position for a lot of people.