Stiglitz: US Paying For Not Nationalizing Banks

Posted by urbandigs

Mon Nov 2nd, 2009 08:20 AM

A: Well, I would think part right. But the core of the argument is that banks have not been lending and taking enough risk in the US consumer. With such excess and buildup of debt over the past decade, Im not sure increased lending and risk is what you want for a US consumer that is in the process of repairing their balance sheet and struggling with a rising unemployment environment. Seems counter productive to me. Time is what we need. Debt restructuring is what we need. Reorganization is what we need. And over time the write downs must be taken and the balance sheet repaired. Over the course of the process, everybody cutbacks. Hence the deflationary pressures. Fighting the natural order of things will only artificially heal things and likely lead to another crisis down the road. In the end, we'll have to finish the repair.

Bloomberg reports that "Stiglitz Says U.S. Is Paying for Failure to Nationalize Banks":

“If we had done the right thing, we would be able to have more influence over the banks,” Stiglitz told reporters at an economic conference in Shanghai Oct 31. “They would be lending and the economy would be stronger.”
So in hindsight, was more lending the answer? Lending right now to a consumer that is facing the toughest labor market in decades and who is ridden with debt already? I'm not sure if its me or not, but it seems such a simple concept to grasp that you cant solve a debt problem by issuing more debt. When the consumer and small business is in bad shape, we will see them start to save, reorganize, and possibly file for bankruptcy protection to restructure existing debts. Well, that is exactly what is happening.

BankruptcySept.jpgDid you know the Personal Bankruptcy Filings are up 41% compared to Sept 2008? Calculated Risk shows us the steady surge in filings since 2006 (click chart for larger picture).

Now we see CIT Group finally filing for bankruptcy. Its the right thing. As painful as it may be for small businesses across the country, its what needs to be done. The US Treasury never should have injected funds for CIT preferred equity and warrants to begin with; and they would have saved about $2.3Bln from the TARP pool. Now the "government investment is likely to be wiped out, said people familiar with the matter." In the end, the same outcome prevailed.

Stiglitz continues:
“The big risk we face now is that banks are going to overcorrect and not take enough risk,” Geithner said. “We need them to take a chance again on the American economy. That’s going to be important to recovery.”
This has been a continuing risk for the past 18 months. Credit has been contracting as excess is in the process of being purged. This is one reason why the M1 Multiplier has plunged:

m1-money-mult.jpg

Our fractional reserve system of multiplying money is not working the way it was designed to because of the flaws embedded in the system itself.

Stiglitz then gets the chord right:
“We have this very strange situation today in America where we have given banks hundreds of billions of dollars and the president has to beg the banks to lend and they refuse,” Stiglitz said. “What we did was the wrong thing. It has weakened the economy and has increased our deficit, making it more difficult for the future.”
The bailout did not cure the entire problem and the banks still have toxic assets held. Yes bids for most assets, especially those tied to securitized mortgages, have been propped up with a massive liquidity driven rally, but just how real is that? And will an extreme positive carry trade reverse itself in a painful way down the road? The fed & govt successfully avoided a systemic banking event that could have led to a very painful global disruption. The failure of Lehman was the closest we got. But we still don't know at what cost this avoidance comes with. We will find out over the years.

Banks simply need to take the write-downs, restructure the debts, reorganize the business models, and come out stronger at the end of the day. If that means bankruptcy or nationalization, so be it. Mike Mayo was back at it again Friday reporting on Citigroup facing another $10Bln writedown ahead on tax deferred assets.

The risk of not doing this is a lost decade with subpar lending even when the US consumer sees a stabilizing or better yet, a growing labor market. Thats the thing, at some point the labor market will stabilize and start to grow again; but how strong will the foundation be and how healthy will the banks be at that time? Accounting gimmickry and 'extend & pretend' can only take you so far! In the end, it all will come out. Bary Ritholtz also chimed in:
"One of the major complaints I have had about the bailouts and faux regulatory reform has been that it spurned the proven solution — the Swedish model — and instead embraced the worst example on the planet: The Japanese model. The refusal to force insolvent banking entities into bankruptcy is a large part of the reason, but its not the only one."
Yes. But one thing the banks actually got right was to CUTBACK LENDING & TIGHTEN UNDERWRITING STANDARDS TO WHOM THEY LEND TO & ELIMINATE EXOTIC MORTGAGE PRODUCTS THAT WERE DESIGNED TO ENHANCE AFFORDABILITY AND CUT CORNERS IN UNDERWRITING!

My main point is, it was prudent for banks to slow lending to a US consumer that was already heavily in debt with housing prices looking for a bottom, in a rising unemployment environment. Arguing for more lending in this type of environment would have kicked the can down the road for another day. A contraction in lending is, while not the American way, one of the healthier things the banks could do given the environment we are both in now, and just went through.

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