Stiglitz: US Paying For Not Nationalizing Banks
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.
Did 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:
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.
Comments (10)
Nice analysis Noah, thanks as always. Nouriel is at it again with a piece in the FT about the next "mother of all bubbles" (commodities and EM), which he slyly qualifies at the end of his usual self-serving gobbledy gook by saying it might not happen for a while. Reading tea leaves should be the first so-called industry to be chucked out the window, in particular from folks who work in places that can't even manage their own endowments...what does occur to me, however, is that US money centers have become de facto extensions of the Treasury. I imagine there will come a time when DC begins to distance themselves from the private sector, but that political turn is measured in election cycles and for the time being, the Federal role seems clear. I personally believe that the only long run exit for the US economy is a reversion to manufacturing and industrial production and a shift away from the financial engineering of the last 25 years. It does not portend well for real estate as an asset class because the notion that outperforming traditional equities, for the time being, does not seem like a winning strategy.
Posted by Fred | November 2, 2009 10:01 AM
Noah,
Any thoughts on how Bernanke will address FOMC this Wednesday?
Posted by In Debt We Trust | November 2, 2009 10:14 AM
While I agree the basic premise that banks should have been temporarily nationalized the banks are holding onto the cheap reserve money because they need to be recapitalized with all the toxic crap they still have on their books.
But it is the small businesses that need the loans not homeowners - thats what the admin is bitching about.
Posted by Holly Martins | November 2, 2009 11:17 AM
Good Post.
I tend to think that out of this collapse most prudent people (individuals as well as business and banking leaders) will recognize that risk/reward, P/E, debt/income, L/V, rent cost/ownership ratios etc....have to return to what experience over much of the past 7-8 decades have proven are reasonable and sustainable values.
Some will never get it I guess (such as when greed and throwing principles out the window are rationalized), but it seems to me a sustainable recovery will only come with debts written off, associated bankruptcies allowed to play out, and sustainable ratios restored. I can't help but think a lot of pain is yet to come. Sad that it will hurt real people.
Posted by daj | November 2, 2009 12:00 PM
Fred - thx! as far as real estate as an asset class, it will never be perceived like it was for much of the past decade or so prior to the bust.
the pain is too deep, oversupply too deep. besides investors and surges in foreclosures, a home is once again being viewed as a place to live, not so much as a speculative asset anymore. At least I think so.
As for role of fed, it remains to be seen at what point they find the political will to do the unthinkable - get hawkish and reign in liquidity facilities to the point where they are tightening. That seems years away.
thanks for comment
Posted by Noah | November 2, 2009 12:40 PM
IDWT - who knows..likely say still economic pressures but that economy is showing signs of stabilization..that liquidity facilities will be wound down as they see fit. that labor markets are still pressured.
no change on rates clearly. doubt they surprise there.
Holly Martins - just a solid point except homeowners are small business owners too. So how interconnected is one from the other? How many homeowners tapped equity to put into their struggling small businesses? Hmm?
But your point is a great one. Small business lending is a victim here. But US consumers, many of which are homeowners that got hurt real bad, are cutting back in general and that hurts small businesses. Unfortunately they are part of the restructuring/reorganization as they adapt to this severe slowdown that was clearly credit + housing fueled.
Posted by Noah | November 2, 2009 12:46 PM
Noah, Does the fractional reserve system mean that banks can created money?
Posted by sechel | November 2, 2009 3:54 PM
no, banks multiply money and create credit. whether you call credit actual money is another story, but I assume you mean actual printed dollars.
for example, depositor A puts 10,000 in a new account. bank must keep 10% in reserves. So bank keeps $1000, and lends out $9000 to Customer A who then buys a used car for the whole amount. Car seller takes $9,000 and deposits in Bank B, who then keeps $900, and lends out $8,100 to another Customer. Rinse, lather, and repeat.
If you take that original 10K deposit, and multiply it the way our system of fracional reserve banking is designed to its fullest, $100,000 of new credit can be created....is this money, yea I guess so, but the bank didnt print it. They created credit.
The US Bureau of Engraving & Printing mints US coins and banknotes. The fed can 'print money' or create money by monetizing debt and purchasing securities from primary dealers and money center banks on account with NY fed. This is called POMO, or permanent open market operations.
In a fiat system, the difference between credit and money is a fine line I guess. If the credit can be exchange for good and services, than I guess credit is money? Money must retain some store of value for long enough to be generally accepted as a medium of exchange. Money is always a store of value, but a store of value is not always money. Bonds are a store of value, but they are not money. You dont buy food with a savings bond. So you convert the bond to money, then go shop.
Posted by Noah | November 2, 2009 4:12 PM
Thank you for the wonderful refresher. It is a fine line, especially if I can take that 9,000 loan, and add to the original 10,000 bank account.
Posted by sechel | November 3, 2009 6:02 AM
New York unemployment is on the rise, but conditions vary throughout the state according to this heat map:
http://www.localetrends.com/st/ny_new_york_unemployment.php?MAP_TYPE=curr_ue
Posted by peter | November 9, 2009 7:24 AM