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We Still Have To Pay The Bill

Posted by Larry Doyle on May 5, 2009 4:16 PM |

Equity markets have rallied back to unchanged on the year. Libor is back to 1%. Housing is showing signs of life. Other economic indicators are declining at a less rapid rate. Fed chair Bernanke provides a cautiously optimistic tone in his testimony today. So why am I as concerned as ever?

Perhaps I do not fully appreciate the benefits of the massive government injections of capital into our economy. Why? I view any short term benefit from the capital injections as merely covering for losses which are still embedded in the system. The bills associated with those losses, in terms of increased interest costs and principal writedowns, are yet to be paid. 

Where are the losses? Well, the results of the Bank Stress Tests have been leaked and 10 of 19 banks will supposedly need more capital. The commercial real estate market is totally dependent on the government committing to 5 yr loans via the TALF.  I view the rebound in the residential real estate market as mortgage mayhem, not mortgage magic.  None other than the IMF continues to highlight that our economy has another $1 trillion plus in losses.     

I will grant Obama and Bush and their respective administrations credit for succeeding to this point in what they were trying to accomplish. However, that success, in my opinion, only means that longer term costs will be steeper and longer term benefits will be further off as a result.

Nouriel Roubini and Matthew Richardson address these points in today’s WSJ, We Can’t Subsidize The Banks Forever.   

From my perch, I view Obama and team as indiscriminately allocating capital across too many programs. I am becoming somewhat concerned that Bernanke is wondering if they have put too many chips on the table.

Roubini and Richardson offer:

. . . stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway. 

While the tone feels better, there is no doubt we still have challenges. Private enterprise’s  interaction with Uncle Sam is one of the biggest challenges.

All this said, the government had a choice between immediate losses with excruciating pain or buying time with long term underperformance. They chose the latter.

We still have to pay the bill.

LD






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