The wildly optimistic view of Treasury’s handling of the crisis

By Edward Harrison of Credit Writedowns

I was reading Kid Dynamite’s account of the recent Treasury – Finance Blogger meeting after having read a bunch of others (see them all in Abnormal Returns’ Nov 4th links). And I was struck by his characterization of the thinking at Treasury in regards to the financial crisis. I want to highlight two points and ask the question: didn’t the Treasury plan work as designed?

I will try not to editorialize and let you draw your own conclusions based on my (hopefully neutral) narrative of their stated goals.

Here is point #1 I want to highlight:

The first point that caught my ear was the description of the stress tests as having been designed to restore a level of confidence in the banking system.   The STO mentioned that the focus was now on reducing the footprint of economic intervention cautiously, quickly and prudently…

a number of STO’s present in the room, who quickly banded together to clarify that no one knew the results of the stress tests before they happened, and that they were designed to restore confidence by identifying the levels of capital needed by the banks, and requiring them to raise such capital.  I said that if they wanted to restore confidence, they should require banks to mark assets to market, and depict the true financial situation.

As I read it, Treasury wanted to show that it had a credible plan to identify any capital shortfalls amongst our biggest banks and to take corrective action.  Their belief is this would restore confidence.

Here is point #2 to highlight – why the need for secrecy:

I [Kid Dynamite] mentioned that the problem was that even if we had a “Counterparty Risk Czar” who somehow managed to magically quantify the exposures of each firm (which may be quite a difficult task in itself), we’d see the same problems we saw when the government went to give out the TARP funds. The government didn’t want to “bail out” select firms (ie, BAC and CITI) because they feared that the stigma attached to such assistance would create panic and runs on the bank – so they asked a large pool of financial institutions to take the money to hide the truly sick cows.

I read this to say that Treasury feared identifying ‘loser’ institutions would have a negative impact and cause bank runs (think Washington Mutual). therefore, they had to hide the ball, so to speak.  The same philosophy is behind the Fed’s refusal to release more information to Bloomberg on the Fed’s emergency lending counterparties.

The overall gist of the strategy was that Treasury wanted to identify the weak, give them time to grow stronger, and, in so doing, allow the panic phase to subside so that corrective action could be taken in a more normal economic environment.

Wasn’t the plan wildly successful? Blogger Accrued Interest thinks so.

Now, before you give a knee-jerk response, please read the following from a post I wrote in April called “Channeling my inner Larry Summers,” which was my attempt to read the intentions of Obama and his economic team (in the voice of Larry Summers). I think it dovetails nicely with what Kid Dynamite says were the actual goals of Treasury.

the question is how do we deal with this crisis.  The first priority must be  to forestall a deflationary spiral because that induces a dead-weight loss and extracts a cost of incalculable consequences.  The best way for government to end the spiral is to temporarily increase spending or temporarily induce more private sector spending.  Is this re-flating the bubble?  No, because deflationary forces will continue to extract a price even with these measures in place.  The key is to avoid a negative feedback loop, a spiral downward, and the easiest way for government to do this is to increase spending.

But, spending alone won’t get it done.  Ultimately, we will need to increase credit availability.  Just because people are spending more, does not mean the economy will grow.  Growth depends critically on increasing credit in line with the growth of the economy.

I am not one for nationalization of banks or other coercive, non-market based mechanisms of getting lending flowing.  The concept that nationalizing banks and re-privatizing them should be a first port of call for a government imperiled by a weak banking system is contrary to the need for limited government.  What we need to do is put a number of government-assisted programs into play — cognizant of that healthy tension between limited government and necessary government — and get credit flowing this way.

Let me enumerate some mechanisms:

  • First we should try bank re-capitalization.  Our first priority must be to have an adequately-capitalized banking system. Absent that, increases in lending are impossible and the system will continue to be doubted. So that’s number one. We can do this through preferred equity so that the government is senior to common equity and receives some compensation for taxpayer money.  What’s more is it limits government interference. Remember – most of these institutions are having temporary problems.  With enough capital, they can weather the storm.  There is no need for heavy-handed government interference.
  • If re-capitalization proves inadequate because of depreciated legacy assets, we will need to remove those assets from banks’ balance sheets in a way that promotes price discovery, increases asset liquidity and respects the tension between government involvement and government’s limitations. The PPIP and TALF can help achieve this.
  • Moreover, by allowing financial institutions to borrow with a government guarantee, we can ease the funding liquidity constraints as well.

Ultimately, the jump start from stimulus and quantitative easing will start to kick in while all of this is ongoing. The result will be a growing economy and healthier banks. Nevertheless, we should implement some stress tests on institutions to gauge how much capital each institution would need in a worst-case scenario. Those banks faring poorest will need to take remedial action as soon as possible. However, under no circumstances should we ever imply that any individual institution is insolvent. This creates doubt and during times of stress it is not the wisdom of crowds, but the panic of crowds that is on display. Doubts about one institution are likely to have knock-on effects for others creating a systemic problem. This must be avoided at all costs.

So have Geithner and his team not avoided the pitfalls and accomplished their goals?

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. CuiJinFu

    It’s far to soon to pass judgement on Treasury’s handling of this crisis. Although their short-term tactics have yielded some improvement, it’s come at a huge cost and they’ve barely begun to extricate themselves from propping up the financial system. You don’t judge the success of a team until the game is over, and we’re nowhere near normal with short term interest rates below 0.1%. To use the common baseball analogy, I don’t see how we’re much past the 5th inning at this point.

    1. albrt

      I would agree with this comment, except that we are ignoring the elephant in the room:

      Why is everyone so hesitant to suggest that a primary purpose of the Bush treasury, the Obama treasury and the Bernanke fed is to enrich bankers and bank bondholders?

      By that standard they were wildly successful, and all their actions to date are well explained. They also succeeded in preventing this Potemkin system of large banks from being exposed as a fraud, but that is important only to the extent it preserves the ability to enrich bankers in the future.

      1. mmckinl

        Exactly correct …

        Banksters and bond holders got bailed while the tax payer gets to pay for the mess which will be trillions of dollars …

        To add insult to injury they use our money to lobby against any reform what-so-ever …

        With the trillions we have or will spend we could could have cleaned up the whole mess and had a healthy banking system with regulatory safeguards …

        Instead we will be crippled going forward with insolvent, weak banks pulling our economy down …

      2. Fed Up

        “Why is everyone so hesitant to suggest that a primary purpose of the Bush treasury, the Obama treasury and the Bernanke fed is to enrich bankers and bank bondholders?”

        I’m not. The fed and the treasury exist to make the spoiled and the rich even more spoiled and richer. Price inflation targeting is a farse!!!

      3. Fed Up

        “But, spending alone won’t get it done. Ultimately, we will need to increase credit availability. Just because people are spending more, does not mean the economy will grow. Growth depends critically on increasing credit in line with the growth of the economy.”

        UTTER AND COMPLETE NONSENSE!!! I see NO reason why an economy could have zero or near zero currency denominated debt. It would help to eliminate debt slavery and reduce wealth/income inequality by a good bit.

      4. mannfm11

        As much as some of these stories give me the red ass, I don’t believe the purpose was to enrich bankers. The basic money supply of the US was on the verge of potential implode, at which point the immediate liabilities of the government could reach $5 trillion or more and the entire economy shut down. It appears GS and JPM were allowed to come out of this mess intact and this should be investigated. The real problem is that the capacity of debts to be supported with any kind of debt service is in the rear view mirror and the crap on these banks books isn’t going to get better. There are 3 types of entities out there, credit worthy who aren’t stupid enough to get into debt right now, those that are and those that are up to their necks in debt and couldn’t pay back in 2 lifetimes. Those that are getting into debt for potential profit are going to be looking down a deep well if those that aren’t getting in debt don’t follow them in a game of passing the bag.

  2. winterwarlock

    The vicious cycle for them is the time those affected have to determine the cause of their position, which is increasingly leveraged by more and more people joining the investigation:

    Ultimately, the “founding fathers” confiscated their property on the theories of divine providence, agency, and eminent domain, sowing the seed of the Constitution’s destruction.

    Typical case: Vermont

    Much more land than people, quite capable of providing all primary necessities, with surplus for export.

    Economy – imports all necessities, exports milk products based on artificial prices, supplies tourist destination and 2nd homes to meet artificial demand of globally subsidized external participants. The typical worker gets $10/hr for temporary work, the typical home costs $350k, and there are more political jobs than productive jobs.

    Politics – non-natural participants control both the vote and all critical decision-making positions.

    Result – with increasing price disclosure, the state “suddenly” finds itself $250M in the hole, and falling fast.

    Proposed political solution – beg for higher milk prices, and cut unemployment payout by 30%.

    What we are watching is speed to disclosure. They hide a problem, their evasion attracts attention, and while they are increasing their effort and cost to hide the original problem, investigation peers deeper and deeper, farther and farther, by an increasing population of people who have lost their livelihood to this incompetence.

    Quite the show.

    Anyway, the banks in Vermont are theoretically sound, and attracting investment …

    The banks here are sitting on properties without disclosing their status, and bartering them across the table to each other, pushing the accounting window out, when and if any discovery is made, and their proprietors place a piece in the WSJ professing the soundness of Vermont commercial real estate.

    Generally, Vermont doesn’t experience recession, because, like the actors, it historically has been insulated. Mr. Fuld vacated the premises, and is being followed by others.

    Meanwhile, property taxes continue to rise, on homes that cannot be accurately re-assessed, and the free riders continue to hide behind artificial, relative inflation.

    Vicious, but quite the show.

    1. Ultimate Janitor

      What about the maple syrup?

      Good example using the state with the least number of residents.

      1. winterwarlock

        Precisely. All kinds of leverage possibilities, a simple system that begs a prototype solution process, and still bad outcomes.

        Mismatched debt is ugly.

        Do not open that can!

        The farther the distance between producers and consumers, the larger the pyramid in between.

        1. wniterwarlock

          in case you missed it II:

          America was employed as a carrot, then its utility expired.

          The jig is up, and it can no longer subsidize operations with a levy on energy distribution around the world.

          Rome is burning.

      2. winterwarlock

        Typical Problem Explained, in case anyone missed it:

        If you cannot see the entire economy, regardless of where you happen to reside, price is meaningless. If you cannot price, you must accept agency, the cost of which is tyranny.

        Oil: planetary production requires thousands of years to produce, and Americans consume it in a matter of minutes. America ships raw materials to Asia, which processes it for return as finished goods, artificially tripling the price of gas, doubling the price of heating oil, doubling the input costs to manufacturing, and catalyzing the export of additional jobs in a vicious cycle, for America, but in the long-term intersts of the planet.

        Fighting physics is like spitting in the wind because you are angry, and getting angrier when the surrounding crowd laughs. Better to laugh with them, and get on with business.

        The most valuable property on earth is that with water, fertile soil, and building materials – the basic components of an economy, which minimizes fixed costs.

        Of course agency will lull you into the city with subsidized initial wages and costs, because, once there, it controls both your revenue and costs, and, like any good booky, agency makes money on volume.

        The only justification for poulation in deficient areas is the best supply of variable demand, diversity. Thankfully, the planet seeks diversity, but city dwellers are completely dependent on external supply of primary inputs, and the farther away those inputs, the greater dependence of both producers and consumers.

        Vermont is quite typical of the problems with agency: you may temporarily benefit from the imposition of dependency on others, but, ultimately, your utility as a carrot will expire.

        how’s that?

        (energy is everywhere; we do not need oil)

    2. joebhed

      wow, never thought I’d have to defend Vermont as an economic model on NC, and I hope Jeb Spaulding or Art Wolfe are reading here today.

      I’m afraid I don’t get the point, ww.
      Are you saying that Vermont is worse-off than her surrounding contemporaries by any economic measure?
      Pre- or post- financial crisis?
      Because I would say NOT.
      Your rhetoric is empty.
      It looks like a John McClaughry article – kinda sour-grapes all around.
      She coulda been more, Vermont.
      Please provide some data to show that Vermont’s long-term policies are going against her well-being in the devolution of America.
      Rising property taxes are a natural result in an economic depression.
      So, again , what’s your point?
      Deflection from the Treasury?

      1. winterwarlock

        if ultimate janitor was a Vermonter, making $10/hr, working under a chain of command entirely populated by non-vermonters, who threatened to fire him everyday, to be replaced by any one of the imported laborers waiting in line outside the door, specifically brought in for the purpose, and owned a 50 year old home, inflated to $350k by Wall Streeters, with $5200 in yearly taxes alone, going up at the rate of 6% a year, in a market with no sales, and for sale signs lingering in yards for up to 2 years, watching non-vermonters come into the state specifically because it is known as an easy entry to welfare, he wouldn’t be very happy.

        That may work for you.

        1. winterwarlock

          Like I said, Vermont is typical:

          The data is the problem.

          The computer said, so I did is the problem.

          A bunch of economists talking about the compiled analysis of second-hand researchers talking to second-hand researchers, who have never done a single piece of valid primary research between them, all of whom are completely dependent on the system is the problem.

          1. winterwarlock

            Oh, I forgot to mention:

            ultimate janitor is going to be replaced at 1/3 the cost due to government subsidies, and in a business attracted from another country to replace a domestic company at a subsidy of nearly $100k per worker …

            by the very same people that proposed a hospital expansion at $80M that became $450M, financed with short-term debt to be rolled over, in which a doctor will repeatedly discharge a guy in the beginning stages of gangrene, and only accept him when it’s time to work on the leg.

          2. winterwarlock

            Well, I stopped by. Sorry to have missed you, or the others …

            but while I’m thinking about foreign companies, you’ll love these two litle babies:

            Proctor & Gamble largely employs temps in other countries, but it gives a test for direct hires in which the answer to every question is some form of do not take direct responsibility for work on the line, talk to your supervisor, and no one other than your direct supervisor.

            Black & Decker, another large employer of temps in other countries has been renting warehouse upon warehouse to store tools that it cannot sell, but it boxes them for sale, puts them in accounts receivable, and sells the company.

            They can get away with this crap because there is no articulation between corporate and government accounting systems, not even for those agreements that include government subsidy to pay for this behavior.

            Corporate accounting is no longer valid, and government accounting never was. You get government numbers a year late at best, and two years late on average.

            But by all means, let’s debate invalid data, ran through invalid statistical analysis, and spoon fed to those who are too lazy to go check for themselves.

          3. winterwarlock

            catch me again later.

            sleep on this thought:

            they are going to pass healthcare to roll over that short-term debt for another day.

            it’s another federally mandated entitlement for which the states are going to have to pay, and the states have how much to pay for it? $0

            welfare income does not count, so welfare recipients will get subsidized, but ultimate janitor will have to pay, on top of everything else he hasn’t the means to pay. And they haven’t told him about the upcomong increase in state taxes yet.

  3. Hondo

    No one is going to re-capitalize the banks when there is no certainty as to the quality of the assets (be hidden by management and government). The only option is to let the market decide the winners or losers or the government decide. To think that all will survive is pure fantasy. The government has screwed this up royally as you can’t trust them anymore than the corrupt CEO of the financial institutions and/or legislators/regulators. We have moved exactly down the same path as Japan the only difference is our culture about how the private sector and public sector should operate is different. In the end this is not going to have a result that much different than Japan and the cost (both current and long-term) will be about the same also. Without changing the path of the vehicle one ends up in the same destination as the previous driver.

  4. ndk

    So, since we’re hopping in the WayBack™ machine here, let’s revisit the spanners Ed saw in the works then:

    “1. The economy will worsen considerably more. The stress tests indicate a worst-case scenario which is unrealistically optimistic.” Check.

    “2. Balance sheets will worsen because of commercial real estate loans, credit card loans and other real economy effects as well.” This one’s fascinating. We have seen incredible surges in various delinquencies, commercial real estate has plunged, and so on and so forth.

    I think we can all agree that the extent to which extend and pretend can be sustained is stunning. Even as cash flows get ugly and bad loans turn earnings negative for some banking institutions, investors don’t care as long as the Fed and Treasury don’t care, and nobody will fail.

    “3. Political capital will be consumed over time. Americans will tire of this crisis.” Very much so. This was written prior to all the 912 stuff and the resurgence of fiscal conservatism in America. Look back at the posts from George Washington yesterday to observe the extent to which you were right on this count as well.

    Thus far, the executive branch doesn’t care, counting on unenlightened self interest to allow a rising stock market to lift all political boats.

    You summarized: “What worries me is that behind Summers’ (and Geithner’s) calculus is a belief that the system is fundamentally sound and that we should not upset the cart.” And they have, indeed, not upset the cart.

    So the fascinating thing to me is, you were right. Absolutely nothing has been solved; absolutely nothing has been reformed. It really has all been papered over.

    I don’t think Treasury has succeeded at anything. They’ve stilted up the existing system far better than I ever imagined they could; I was wrong. But all the prior problems are still there, and they’re getting worse.

    * Bad loans? Deliberate policy now, according to Frank. Nearly 5% of FNM’s held portfolio is 90+ days delinquent. Junk has soared in price even as defaults have increased too.
    * Overcapacity globally in labor and capital? Investment is surging in China, while consumption trickles gradually higher. Unemployment is high world-round, and wages are falling. We have natural gas coming out our ears. Everyone is sloshing into precious metals now.
    * Global trade imbalances? American imports are again faster than exports, and doing so from a higher base.
    * Excessively large financial sector? More so every day.

    Buying time by worsening existing trends and indebting the taxpayer to this degree isn’t benign. It’s dangerous and foolish.

    I’ve learned only one thing. Never underestimate what will occur when the Fed explicitly indemnifies everyone against all risk.

    1. Edward Harrison Post author

      ndk, you got me, I did say those things! I obviously agree with Kid Dynamite’s feelings here. I’ll try to stop from running at the mouth, so others can get their thoughts in..

      Obviously I am trying to frame this to look at the counter-factual to elicit some good responses like your own. I’ll give you my two cents in due course.

      Maybe we will even get some pro-Administration responses?

  5. Kid Dynamite

    hi Ed – thanks for reading. My point is pretty simple: the Treasury has solved nothing – it has kicked the can down the road. I don’t know how anyone could really debate this fact. Yes – they have FORESTALLED bankruptcy/reality/recognition of bad debt – but that doesn’t make the bad debt go away! After all, one of the main tools was to simply ignore the market values of the debt and hope it “comes back”!!! So, the Treasury’s plan worked if the plan was to stick a finger in the dyke, so to speak, but NOT if the plan was to actually FIX the system.

    Government stimulus will pump all metrics – GDP, housing, retail spending, (although they haven’t figured out unemployment yet) – but when that spending stops, so does the artificial pump. Don’t forget that it’s not just the consumer who is broke – it’s the country. Of course, we can just print more money – for now.

    Is it possible that the Fed can just buy all the bad debts that the nation has accumulated over the past 20 years, and eat a trillion dollar loss? Maybe – i guess that actually IS possible – that the taxpayer eats the loss for corporate and retail America – but i don’t know what the consequence is.

    1. Kid Dynamite

      to use an overdone analogy – it’s like giving a drunk another shot so he doesn’t get a hangover…. The hangover is coming one way or another – you cannot avoid it. And giving him another shot just makes it WORSE. I’ll get to this in part II of my recap.

    2. ndk

      Is it possible that the Fed can just buy all the bad debts that the nation has accumulated over the past 20 years, and eat a trillion dollar loss?

      I see two problems here, Dynamite.

      The more interesting problem is the assumption that bad debts are a thing of the past, a limited time only thing, and not a structural issue. It’s theoretically possible for an economy to end up in a situation where the aggregate real risk-adjusted return on lending is negative.

      If you look at estimates of that rate for the US, it’s been falling ever since the Great Moderation began, and was around 1-2% over the last several years. It doesn’t strain credulity at all to imagine we’re negative now. The trend has been down in other major industrialized economies, as well. China has had a lingering deflation problem since ’98.

      So far, the Fed has avoided addressing this question by aggressively kept interest rates low AND absorbed a lot of risk. Not too hard to make the risk-adjusted return on lending positive if there is no risk.

      But by depressing the price of risk and encouraging lending and investment to take place that is not economically sound, we’re just depressing the future rate of return even more(by creating an even larger overhang of debt and capacity). Just look at fixed investment in China still surging ahead today. I think this is incredibly self-defeating. Another way in which we may be exacerbating the longer-term problem.

      This brings us to the second problem: just how much bad debt can the Fed absorb? Difference of magnitude can become a difference in kind. And I have no idea. The Fed’s balance sheet for this purpose should be consolidated with the rest of the Federal Government. But the inevitable outcome of too much Federal debt is not at all necessarily inflation. There’s a whole panoply of bad options to choose from.

      So, the Treasury’s plan worked if the plan was to stick a finger in the dyke, so to speak, but NOT if the plan was to actually FIX the system.

      We would all do well to bear in mind that Geithner is a serial dyke finger-sticker. From the 1993 crisis through LTCM and other debacles, he’s always poked his finger in there, and it’s served the system and country well, superficially.

      There are some of us who believe that the build-up of debt relative to GDP during this period of placidity and eternal Fed puts was extremely bad, and part of the problem. We’ll have a good chance to test that theory again in the future, as the monetary base water rises higher relative to flows by the day.

      The other part of the problem that nobody’s solved, btw, is China’s peg. It’s impossible for the US to get any inflation going until we do something about that, and China has every motivation to maintain the peg(and fight domestic inflation — deflation suits them much better than inflation, with very little household debt and plenty of experience mopping up dead banks).

      The only way we can fight back, really, is through tariffs, and I don’t see us imposing that. It’s against our doctrines, our ruling classes, our trading partners, and the WTO.

      1. ndk

        If you look at estimates of that rate for the US

        “that rate” being the real natural interest rate, sorry.

    3. Richard Kline

      So Kid Dynamite, check to all that. ‘Kick the can down the road’ is, to me, the real assessment as to the win-value of the Paulson-Summers bailout plan. Here is a point to take from your remarks on a new vector, though: the diagnosis of the policy folks with whom y’all were invited to hob and nob is that ‘panic was the problem,’ and they give themselves solid marks for forestalling panic. But this is false: insolvency was, and is, the problem. It was, and is, the self-interested view of _the big, broke banks_ that ‘panic was the problem,’ though, and they sold the Guvmint types on that.

      To be fair, panic can be a problem in financial crashes, and we assuredly had both a crash, and in Sep 08-March 09 a panic. But the diagnosis of the Treasury types was, and is, that the panic was fundamentally unwarranted, and thus the real problem was contagion taking down ‘sound’ institutions. I feel strongly looking back at events that this was Paulson’s worldview, and that this remains Suummers and Geithner’s worldview; I’ve been meaning to comment on this at some point but haven’t had the time or window on it. Along this line, I think that Summers, the Treasury folks, et. al. feel storngly that asset prices are ‘abnormally surpressed’ as a result of the panic, and that once ‘normal consumer activity’ returns ‘confidence will be restored’ and prices ‘will recover to realistic valuations.’ That’s it in a nutshell. Paulson, Summers, et. al. have drunk the koolaid, convinced themselves that the bubble-top numbers were the real ones and the crash-trash numbers are ‘mistaken.’ In that context, it is the function of public policy actors to string things along until the public comes to its senses. In any respect, this is exactly what said public policy makes have done, used the soveregin credit of the country to 1) forestall panic, and 2) kick the can down the road until the consumer starts borrowing again, so that 3) prices return to ‘real values,’ and things return to normal.

      —But the diagnosis was both wrong and selfishly wrong. The problem wasn’t panic, the problem was that the assets really weren’t worth the money borrowed against them, that debt forestalls price recovery, and that hence many big banks were, are, and will remain rotting zombies. By the time that, Japan-style, the permanent morbidity of said large banks becomes inescapable, it will be the sovereign credit capacity and public finances of the country which have caught the Red Death. What is really striking to me about this misdiagnosis, supposing that I see this all accurately, is the extent to which the enablers of the bubble—Summers, Paulson, and many of the policy actors, directly or indirectly—who provided some face time at lesser levels, are unwilling to admit that they were wrong, or that their friends and peers acted like drunken, thieving, mooks, and therefore that they all were, and ARE, drunken, thieving, mooks only now spending out of the public checkbooks to make their private marks look good for another few quarters.

      The intellectual self-over-valuation of all those folks in this is unspeakable, really. But I’m sure that they see no falseness or even irony in sitting there and reassuring us all that they’ve done the right thing by the country with pretty good results. When the public debt of the country goes spongy, I’m sure they’ll all sit around in their meetings wrinkling their brows asking each other how the heck THAT happened? “I mean NO ONE [whose opinion is worth our time] say _that_ coming, and I right guys?”

  6. nowhereman

    The point I take away from this, whether successful or not, is that no-one seems to find the fact that the TPTB don’t BELIEVE that the citizenry can handle the truth.
    They just snowed everyone and no-one seems to care.

  7. JL (aka Spudthorpe)

    I haven’t seen anyone ask what I consider to be the most basic question: why were stakeholders – especially bondholders, although to some extent also shareholders and management – of failing institutions treated so gently?

    If Treasury had taken the same actions, but extracted a heavy toll from bank bondholders – thus reducing the burden to taxpayers and putting the pain where it belongs – I would take a much more charitable view of their behavior. As things stand, however, I can only view their actions as theft from the public purse on behalf of financial institions and their stakeholders. Remember, financial firms and stakeholders knowingly made risky investements and saw spectacular gains in past years due to phantom profits. Why are the rest of us paying to bail them out? We need a functional banking system, but that does not mean we need to defend bank bondholders.

    1. Kid Dynamite

      bingo. I asked Barney Frank this question at a town hall meeting many months ago, and he tried to blow it off twice, changing the subject to the poor auto workers (i asked him why the bank bondholders were treated so much differently – better – than the auto bondholders) before finally acknowledging that there was disparate treatment, but offering no explanation

  8. john c. halasz

    Well. to avoid redundant effort, I.m just copying a comment I made on another blog, with regard to Stiglitz’ claim that we’re paying the price of not having nationalized the banks.

    It was clear to me from the get-go that public receivership/nationalization of insolvent banks was far and away the most functionally efficient response to the crisis. (I googled myself last Jan. and found my first comment on this was on 4/05/08, after Bear Stearns). For one thing, it avoids the impossible problem of pricing structured securitizations, which simply go into a bad bank, supported by a debt-to-equity swap of the bondholders, to be run off in due course. (DeLong claimed that all bank bonds should be guaranteed, but actually only new bond issues would need to be. He seems unaware that when the secondary market price of a bank’s bonds goes down, the bank is allowed to book an accounting gain due to the decrease in its liabilities, even though it doesn’t actually re-purchase those bonds). For another, by forcing early realization of losses, it limits their scope and prevents gambling for redemption. Thirdly, by guaranteeing adequate capital and a sound balance sheet through re-capitalization, it alleviates the credit crunch to creditable borrowers. Fourthly, the distributive consequences of not doing so have been awful, not just because the perpetrators of the crisis get bailed without relief to the bystanders or victims, and the moral hazard issue that results, and because the tax-payer absorbs the costs, instead of the risk-taking creditors, but because forebearance, subsidies, and efforts to maintain fictitious or inflated assets prices create a drag on needed re-alignments and suck off capital from investment in realigned sectors. And with a significant portion of the banking system in public hands, it permits a review of operations and the development of a new regulatory regime, including breaking up TBTF oligopolies.

    But such a prospect had to be prepared and legislated beforehand, for policy consistency and rule-of-law reasons. For ideological reasons, as much as out of sheer incompetency, that wasn’t done, even though Bear Stearns offered more than ample warning. (Commercial paper loaned to Wall St. actually increased in the aftermath, which regulators should have prevented). As a result, we’ve gotten a shameful public spectacle of massive public bail-outs of the perps and huge guarantees and subsidies, accounting forebearance that does nothing to resolve the issue, money-printing and a monetary policy lollapalooza, and a reflation of asset markets in new bubbles to avoid write-downs and boost profits artificially to assist “private” re-capitalizaton, with the government conducting phoney “stress tests” in a deliberate scheme to inflate bank stock prices, which amounts to a fraud upon the public. (Though why anyone would want to invest in bank equity at this point eludes me, as earlier re-capitalizers got foreseeably burned, and further losses are certainly concealed on the balance sheets). Meanwhile, banks can borrow at zero interest and purchase T-bonds, issued in part to bail them out, for a risk-free positive carry, which is utter absurdity. It’s clear that the debt load of the U.S. economy is excessive, and one way or another, the economy as a whole must undergo a chapter 11 bankruptcy re-organization. The thing is a systematic program to reduce household debt levels to sustainable levels, while letting assets deflate to sustainable prices, would have the same functional effect as monetary reflation, but with much different distributional and functional effects than the monetary lollapalooza. Not least would be the effect of reducing the size and power of the hyper-trophied financial sector. Instead, we’re getting a monetarist solution to a crisis largely caused by monetarist ideology.

  9. Hugh

    This post is plain and simply irritating.

    “The overall gist of the strategy was that Treasury wanted to identify the weak, give them time to grow stronger, and, in so doing, allow the panic phase to subside so that corrective action could be taken in a more normal economic environment.”

    How are weak banks growing stronger? Where have all the crap assets gone or not gone? What is normal about the current economic environment? How did the stress tests suddenly become indicative of anything? Where is this credit I keep hearing talked about? Which banks were the supposedly strong ones? Goldman, Morgan Stanley? If they hadn’t had access to government credit lines they would have been as dead as the others. Where would JPM be if it were not TBTF? They are all zombies, then and now. The fundamentals of the real economy continue to deteriorate. Depression has only been delayed, not avoided. In short, stop drinking the kool-aid.

    1. Edward Harrison Post author


      I think a few other commenters (ndk, for example) are on to the fact that I am merely playing devil’s advocate. I am not sure you are.

      Rather than seeing this post as irritating, I ask you to look at it as a potential insight into the mindset driving economic policy right now.

      1. Kid Dynamite

        yes Ed, and again, as I’ll get to in Part II of my recap, I don’t think the treasury officials are stupid and think they’ve achieved “mission accomplished” – but as you pointed out – what else could they do? Extend and pretend! push and pray!

        Look – i’m a huge critic – i’m not advocating what they have done – but i think that from THEIR point of view, it’s political. I read a quote recently about how politicians in times of strife can never do the right thing because doing the right thing means being voted out of office. That’s KINDA how i interpret the Treasury’s actions.

      2. Hugh

        Seeing the country’s economy crash and burn in slow motion makes me, shall we say, sensitive. You say this is their thinking but you never say why they never ask any of the questions I asked. They are pretty obvious ones. If the idea is that they have a logical framework in which they are operating, glaringly contradictory data would need to be addressed. If you are playing devil’s advocate, you still need to explain why all the countervailing evidence is being discounted.

  10. RueTheDay

    Kid Dynamite demonstrates all that is wrong with libertarianism:

    “The concept that nationalizing banks and re-privatizing them should be a first port of call for a government imperiled by a weak banking system is contrary to the need for limited government.”

    The need for limited government? What need? Don’t project your ideological OPINIONS into facts.

    If a rowhouse in the middle of a city block catches fire and threatens to burn down the whole street and possibly ignite the fuel depot on the corner threatening the entire city, the first task of the fire department is to put out the fire, not opine about the need for limited government and seek to minimize government interference in the natural progression of the fire.

    1. Kid Dynamite

      @RueTheDay – relax and work on your reading comprehension. the quotes you pulled from Ed’s piece above are NOT MY QUOTES! they are the OTHER SIDE of the argument i was making – and they are from Ed..

      now – I await your apology for asserting that i represent all that is wrong with libertarianism

  11. Anon

    I still haven’t seen anyone answer the fundamental question of how we get the debt out of the private sector. I see three outcomes:

    Mark all debt to market, sell it off at a severe discount to someone who has an incentive to negotiate a severely discounted pay back from the borrower. This will take years, if not decades to work through. Even worse, as long as debt is marked to fantasy and guaranteed by government this doesn’t work.

    Have the government pay off some big chunk of the private sector sector debt with newly-printed money, and then sop up the excess liquidity. Debts are reduced and creditors are paid back.

    Go the route of Japan. Debt never gets paid back or written down, and the economy drifts ever downward.

    Am I missing something? And why are we choosing door number 3?

    1. Kid Dynamite

      we’re choosing a mix of door #2 and door #3 – because American couldn’t handle anything else… YOU CAN”T HANDLE THE TRUTH! politicians cannot make the right decisions – because it will result in them being voted out of office

    2. john c. halasz

      “Mark all debt to market, sell it off at a severe discount to someone who has an incentive to negotiate a severely discounted pay back from the borrower. This will take years, if not decades to work through. Even worse, as long as debt is marked to fantasy and guaranteed by government this doesn’t work.”


      Option 1 wouldn’t necessarily require years in the sense pre-occupying general financial and economic activity. What it would require is a general and expedited process like an RTC, though on a still larger scale, to take the bad debts out of the system and resolve them separately from ordinary transactions. That would require both a generalized method and scheme and the breaking of particular contract provisions in favor of uniform procedures, but then the legal breaking of unfulfillable contracts occurs all the time: it’s called bankruptcy.

      1. Anon

        True. I was thinking in terms of private sector “vultures” buying up the debt at a discount and then negotiating with borrowers with threat of bankruptcy – that would take years. The point I was making, albeit poorly, is if the debt is guaranteed and not marked to market, the incentive for a workout/principal reduction doesn’t exist.

        It just seems bizarre to me that the worst possible path is the one we’re heading down.

        1. john c. halasz

          Well, there was PPIP, which was supposed to facilitate the entry of vulture funds, though I haven’t heard a peep about PPIP for many weeks now.

          As I said in my cross-posted comment above, the reason that U.S. government policy is so incoherent is that it amounts to pursuing a monetarist “solution” to a crisis rooted in a long course of monetarist policy/ideology, (“the great moderation”), which is not merely insane or unjust, but, worse, won’t work IMHO. Reflating fictitious financial asset prices to maintain financial flows and resolve the impaired assets by minting artificial profits will do nothing to address the underlying causes and problems of the crisis: global trade and for-ex imbalances (and volatility), excess productive capacity, deficient wage-based demand, etc. Rather it distracts from those issues and detracts from their resolution by sucking investment capital, of whatever sort and source, away from real productive investment and restructuring. But it’s ideological taboos, as much as the daunting technical, administrative, legal and political challenges to a coherent restructuring program, that prevents any recognition of a functional way forward.

          Having watch a clip of Roubini on the U.S.$ carry trade on CNBC earlier today, I think the prospects of another blow-out are downright scary.

    3. Fed Up

      Anon said: “Am I missing something? And why are we choosing door number 3?”

      How about because the idea is to debt enslave the lower and middle class to the spoiled and the rich (as in making sure the lower and middle class never pay off the debt and never default on it)?

  12. Skippy

    AW-WW everyone that attended the Treasury gig got the super secret STO decoder ring, not fair, not fair!

    I’m calling my lawyer Harvey Birdman at Hanna Barbara inc right now!

    BTW some video on the after drinks session, enjoy!

    Skippy…hay does it glow in the dark?

  13. goodrich4bk

    Rue the Day, the fire analogy has limited utility. We are dealing with bad loans and collateral that has inherent value. We are not dealing with tinderboxes. For example, if conservatives hadn’t blocked cramdown legislation, many of these loans would now be restructured by bankruptcy judges into secured performing loans and unsecured discharged loans.

    As others have noted, this would simply reveal the “truth” about the value of such loans based upon the relatively precise and non-political judicial process of competing appraisal testimony. I don’t know if we could “handle the truth”, but first things first.

    Until the truth is known, disclosed and acknowledged, everything else our government is doing is merely continuing the fraud and obstructing justice. Indeed, the extension of the home buyer tax credit this week is a good example of our government participating in the industry’s continuing lie that values have reached a “bottom”. With interest rates at historic lows, shadow inventory being kept off the market, and Option ARM recasts just beginning to occur, no reasonable analyst would recommend that a young person stretch to buy their first home at even today’s prices. Yet that is exactly what we are doing — encouraging young people to overpay for homes they will almost certainly lose in the next leg down.

  14. bobh

    The answer to Mr. Harrison’s question is pretty simple and it keeps getting said over and over again by posters here and elsewhere. Our society has been living beyond its means for a long time, piling up debt in a way that is unsustainable. This is true for individuals in the U.S. in the aggregate, for U.S. banks, and for the U.S. government. If additional credit is available, however, a society or an individual who is bankrupt but living beyone his/her/its means can keep partying. The only thing that makes a bankruptcy declaration unavoidable is a removal of credit. Credit has dried up for most individuals but not for our government. Our government still has credit because it can make promises to repay debt based on its ability to tax current and future taxpayers. For political reasons, our government has decided to borrow money to keep the party going for as long as possible while things get worse, pretending that somehow our society can collectively work its way out of its hole through “growth”. We can’t; but we party on while the credit lasts. The bankers working at the bankrupt banks are enriching themselves while this is happening, but that is really just a subplot to the story. It’s The Grasshopper and the Ants, but I don’t think there will be enough ants to take us all in when winter finally comes and nobody wants our bonds.

  15. i on the ball patriot

    From your “Channeling my inner Larry Summers,” piece, in the section where you state, “the question is how do we deal with this crisis.”, you say;

    “But, spending alone won’t get it done. Ultimately, we will need to increase credit availability. Just because people are spending more, does not mean the economy will grow. Growth depends critically on increasing credit in line with the growth of the economy.”

    What you call credit availability is in reality ‘power’ availability. Credit availability without a modifier, i.e., ‘fair credit availability’ or ‘unfair credit availability’ is meaningless. Similarly, growth, with out a modifier, i.e., ‘good growth’ or ‘bad growth’, is also meaningless.

    When you control credit availability (power availability), you control; the amount of money used, who gets the money, the use of the money, and, most important, the indenture (a variety of terms of enslavement for its use). This is a power that in its aggregate controls the economy, — with all of its resource distributions — and the value of its money. That power has been, and is now, being abused by the wealthy ruling elite. To ‘recapitalize’ that power abuse is folly.

    For these reasons the state (a democratically controlled state) has a very strong interest in controlling credit for fair and balanced growth. It will require that the ‘power’ of credit be made available equally and severely limited in its terms of indenture. It won’t happen in the framework of the existing despotic scamerican system. In fact it will get severely worse.

    It is interesting to note that over the past five hundred years or so, as the deceptive enslavement power of credit has been rationalized and sold to each generation by sell out shill scribes of each generations elite, it has replaced the physical chains of slavery. But make no mistake. It is still slavery.

    Deception is the strongest political force on the planet.

  16. goodrich4bk

    bobh and i on the ball patriot: great posts!

    The Great Depression was merely to point at which credit growth reached its natural, mathematically determined apex. Yes, had Bernanke been living then, perhaps we could have gone another five, ten, twenty years beyond that apex by debasing our sovereign credit and then our currency, as we are doing now. But the result would have been the same, perhaps even worse, for having kicked the can down the road.

    Today’s boomers, particularly those in Washington, suffer the conceit of believing that kicking the can changes its nature, and that the can, once found down the road, will somehow be less dangerous than it appears to be today. The argument goes something like this: values are expressed in dollars, so if we delay the recognition of losses until the dollar sufficiently depreciates, the losses can be avoided.

    When expressed in those blunt terms, the argument becomes a truism. Of course the losses, as expressed in dollars, can be avoided. But the dollars, as expressed in losses, cannot. In short, down the road the can represents a lower standard of living, perhaps partially offset by the general improvement of living standards over time and, most importantly, the public’s tendency to forget if not forgive.

    As for myself, I do not intend to forgive or forget. I am closing my bank accounts and have already cut up my credit cards. I will support only well capitalized local banks with my dollars, but will continue to hold a significant portion of my liquid wealth in gold and silver until I am more fairly compensated for the purposeful currency debasement the Fed is presently pursuing.

  17. Skippy


    Insert any individual with blood on their hand with regards to this mess, as they explain their actions to a therapist.

    Jill’s song or Americas song.

    Please read comments below and if your comp graphics can, HQ it and full screen please.

    Skippy…reality can be

  18. fresno dan

    ndk says:
    November 5, 2009 at 4:02 pm

    That is a really interesting observation. I have thought for a while about how many defaults, at a rate of interest, would cause loans not to be profitable. I couldn’t make heads or tails, but you have stated it elegantly – they were not making money! And they’re not now! And it looks like they won’t be in the future.
    It was ?Hebert Stein? who said something like, “Things continue until they can’t.”

  19. Mickey, Akron, Ohio

    So, ultimately, it doesn’t matter whether Democrats or Republicans control the Executive Branch, right? State-sponsored looting by the financial elite! As Summers’ comments make abundantly clear the taxpayer is and will be on the dime – making the banks and their share holders whole whatever it costs and however long as it takes.

    And with the combined effects of the stimulus package[s] and the printing press DEBT will ensure that we, our children, and their children will travel down the OTHER ROAD to SERFDOM. Is this what “kicking the can down the road” really means?

    If I’m missing something please tell me as I sink ever deeper into DEPRESSION!

  20. bobh


    ‘So, ultimately, it doesn’t matter whether Democrats or Republicans control the Executive Branch, right?”

    I’m a Democrat, and watching Barack Obama inherit this mess and take a pass on trying to “change” the scary trajectory of 21st Century American capitalism was painful for me because he was actually in a historical and political position to try to pull off the difficult set of moves that this would entail. Getting the financial sector under control would have been difficult, but it seemed possible last winter. Getting the American people to accept a reduced but sustainable standard of living, with a halfway decent safety net and reasonable health care for poor people, without creating a massive debt bomb for our children would have been even harder. I’m not sure if Obama weighed the politics of the situation and decided his best chance at getting re-elected in 2012 was to try to get another bubble started so he could kick the can down the road, or whether he actually believed (and still believes) he was hiring,in Summers, Rubin, et. al., the best and brightest minds from Cambridge, to tell him how to save the world by bailing out insolvent banks, dead car companies, etc. Either way, I think he made a mistake. When this bubble bursts and another chance comes around for someone else to try to clean up the mess, whoever is in office will be starting from a lower point with less national wealth to work with. I still think that person will need to come from the social-democratic, left-of-center side of things, but I don’t see anyone in the Democratic Party who seems up to it. I wouldn’t have bet on FDR either, however, so I will wait and see if a leader appears. Sadly, I am mostly thinking about what and how drastic my personal strategies will need to be to get my own family through the coming decades. This is hard for Democrats.

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