Satyajit Das is a bright lucid star amid dim professional optimists....
Banks remain in the ICU (intensive care unit). Even after around $900 billion in new capital, the global banking system remains short of capital by around $1-2 trillion. This translates into an effective reduction in available credit of around 20-30% from previous levels.
Recent excitement about the "stress tests" of U.S. banks misses an essential point. At best if you accept the premises of the test, the risk of failure of these institutions is much reduced. But the banks’ ability to support lending levels that prevailed in say 2007 has not been restored. In short, the "credit crunch" or shortage of borrowing will continue for a prolonged period.
The financial system will need continued government support for some time to come. The performance of governments trying to rehabilitate the financial system has been problematic. Increasingly, government officials have become focused on “reassuring” the public and maintaining “confidence”. The “political spin” has dominated substance. Many government proposals are “stillborn”; for example, progress on the famed Public Private Investment Partnership (“PPIP”) has been painfully slow.
In April 2009, Elizabeth Warren, Chairperson of the TARP Oversight Panel Report questioned the very approach to resolving the problems of the financial system: “Six months into the existence of TARP, evidence of success or failure is mixed. One key assumption that underlies Treasury’s [PPIP] approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from non-functioning markets for troubled assets. On the other hand, it is possible that Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth.”
Richard Neiman (New York State Superintendent of Banks) and John Sununu (former New Hampshire Senator), two other panel members, issued dissenting findings noting: “We are concerned that the prominence of alternate approaches presented in the report, particularly reorganization through nationalization, could incorrectly imply both that the banking system is insolvent and that the new administration does not have a workable plan.” Many would question the selection of the words “incorrectly imply”.
Constant changes do not suggest a consistent and well thought out strategy in dealing with the problems. Less than rigorous stress tests, using taxpayers monies in different guises provide lopsided subsidies for private investors to buy distressed assets with minimal risk or converting preferred stock into shares to avoid having to seek additional congressional mandates suggest a highly politicised and ideological approach. One online commentator noted the intersection between Wall Street, Constitution Avenue and Main Street was best named: “Confusion Corner”.
Suggestions of political influence and a palpable lack of transparency are emerging. There are allegations that the Henry Paulson, the previous U.S. Treasury Secretary, may have “pushed” Bank of America to consummate its controversial acquisition of Merrill Lynch when it sought to withdraw after additional losses came to light. Certainly, the purchase of Merrill Lynch does not fit comfortably with Ken Lewis’ (Bank of America’s Chairman) earlier statement that “he had just about as much fun in investment banking as he could take”.
The Treasury secretary is alleged to have suggested that Bank of America’s management and board could be removed if it did not proceed. There are also suggestions that both the Treasury and Bank of America decided to avoid public disclosure of these events.
The appointment of Timothy Giethner and Larry Summers initially was viewed favourably. The feeling was that “they knew where the bodies were buried”. Critics pointed out that this was because they may have put them there! The “closeness” between banks and government officials and regulators that is being exposed daily is increasingly part of the problem in dealing with the real issues.
Mancur Olson, the American economist, in his books (The Logic of Collective Action and The Rise and Decline of Nations), speculated that small distributional coalitions tend to form over time in developed nations and influence policies in their favor through intensive, well funded lobbying. The policies result in benefits for the coalitions and its members but large costs borne by the rest of population. Over time, the incentive structure means that more distributional coalitions accumulate burdening and ultimately paralysing the economic system causing inevitable and irretrievable economic decline.
Government attempts to deal with the problems of the financial system, especially in the U.S.A., Great Britain and other countries, may illustrate Olson’s thesis. Active well funded lobbying efforts and “regulatory capture” is impeding necessary actions to make needed changes in the financial system. For example, the Centre of Public Integrity reported that the expenditure on lobbying and political contribution of the top 25 sub-prime mortgage originators, most linked to large U.S. banks, was around $380 million (the Economist (9 May 2009).
Larry Summers, an uncompromising advocate of deregulation and liberalization blamed the Asian crisis, in part, on “crony capitalism”. Increasingly, government actions to rescue and re-regulate the financial system display many of the characteristics of the policies that Summers once criticised.
The phrase - “military industrial complex” - described the complex inter-relationships and influences that shaped America in the post-war era. The “finance government complex” (dubbed “Government Sachs” by its critics) replaced the original arrangement in the late twentieth century and may well prove to be the undoing of American economic dominance.
© 2009 Satyajit Das All Rights reserved.
Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).
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