The mad experimenters: Part 2, I must have known it all along
[Continued from yesterday's Part 1.]
By: David A. Smith
Yesterday we saw infallible proof of ‘green shoots’ in the economy – officials taking credit for something. Although the credit-taking may be premature – but hey, it is the political vaporware that keeps on refreshing – that we are still alive to apportion credit means we succeeded in something, didn’t we?
Every experiment you walk away from is a good one
As reviewed in the Wall Street Journal, there were three big swings:
Don’t get cheated on those, okay?
Economists, officials and other observers say that among the more unusual measures, the following had the most oomph over the past year.
1. Rescuing ‘Not Quite’ Banks
In the 24 hours after the Lehman bankruptcy, Reserve Primary Fund investors tried to withdraw $24.6 billion, less than half of which was actually paid to them.
Bank deposits have been insured by the FDIC since the 1930s, but $2.5 trillion in money-market funds weren’t.
Yet another example of why we need to cut up the regulatory turf and standardize financial regulation.
That didn’t stop the Treasury and Fed from rushing to the rescue. The Treasury, which didn’t yet have any TARP money, dipped into a kitty created decades ago to support the U.S. dollar, and guaranteed money-market investors that they wouldn’t lose their money.
That was a critical, essential move.
I guarantee you won’t lose your money
Within a week, the Fed had financed $73 billion in commercial paper; within two weeks, it had financed $150 billion. But that didn’t suffice. Companies still were having trouble selling commercial paper and that meant they couldn’t get short-term loans to run their businesses. So a few weeks later, stretching its own rules, the Fed found a way to lend directly to industrial companies. By January 2009, it had lent $350 billion.
Today, the Treasury says the money-market fund deposit insurance arrangement will lapse on schedule at month’s end, and the Fed’s commercial-paper lending is down to $46 billion. One problem on the crisis list is close to being crossed off.
I hadn’t followed these figures.
That is an unequivocal win.
I like wins
2. Backing the Banks
The financial system only began to stabilize around Oct. 14 when the Treasury chucked its previously announced intention to buy toxic assets from the banks. Instead, Messrs. Bernanke, Paulson and Geithner tapped TARP to force-feed $125 billion of taxpayer money into the biggest banks and pushed the FDIC to guarantee newly issued debt.
I said at the time it was a great move for the country. It cut through the complexity and valuation challenges inherent in auctioning the complex asset pools, and it delivered capital where it was needed. It was, in short, the simplest and most direct solution to the visible problem.
Make contact with the problem
The combination of capital and guarantees, in hindsight, was potent. “I believe it worked … because … those transactions were designed to convey a piece of info: The government is guaranteeing the banks,” says Damon Silvers, an AFL-CIO lawyer who sits on the five-person TARP oversight panel created by Congress and has been critical of some of the specifics of the Paulson and Geithner Treasury’s rescues.
This was a sweeping move, one that captured healthy and sick alike:
To the consternation of its critics, the Fed and Treasury’s October 2008 bank rescue didn’t attempt to distinguish between healthy and sick banks. In fact, it soon became clear that neither Citigroup Inc. nor Bank of America Corp. had enough capital to convince the markets they could absorb the losses likely in a deep recession.
Because even healthy banks were strong-armed into taking capital they didn’t need, on terms they subsequently found onerous, whether it was the right move for all the affected banks is more problematic. Yet in macroeconomic terms, that is secondary:
It didn’t cure the banking system. It bought time. But in October 2008, buying time was what Mr. Bernanke and Mr. Paulson say they figured they had to do.
Yes.
3. Stress Tests
Can you handle the stress?
Mr. Geithner’s “stress tests” of the 19 largest financial firms got off to an inauspicious start on Feb. 10 when he unveiled them in a widely mocked speech. [Snip] But when they were completed in May, they seemed to clear the air and paved the way for banks to raise capital from private investors. “I don’t understand why people were so persuaded by these stress tests,” says [Anil] Kashyap, the
Kashyap wonders why people were persuaded
The answer comes from the preceding section – forcing capital into every bank provided one piece of information (we stand with you all) but obscured another (which of you can stand by yourselves). The markets needed that knowledge as well:
The stress tests … made clear which banks were strong, and which weren’t. Then banks were told they needed to raise capital privately or swallow more government capital.
You have to show you can perform under stress
It turned out that eliminating some of the uncertainty — both about the government’s intentions and the condition of the big banks — was more important than the money the Treasury put on the table.
Not only are fuzzy boundaries bad boundaries, fuzzy readings are in some ways worse than no readings at all.
But Mr. Geithner, in remarks last week, also emphasized that unemployment — the most visible of all measures of economic pain — remains high. And he cautioned, “The classic mistake people make is they declare victory too soon, they put on the brakes too early, they withdraw these things and then the system has to go back and build more insurance against the risk of a bad outcome and that could intensify the recession.”
The banking system is stable – but it’s living on life support, and that’s called the sovereign guarantee.
You can trust me. I’m a doctor.
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