Wednesday, April 15, 2009

And Now You Find Yourself In '82?

As Simon Johnson notes, the administration seems to be following a different script for dealing with the banks from the liquidation/receivership/subsidization troika Elizabeth Warren outlined in her last TARP oversight report. This fourth option - what Simon Johnson calls "forebearance" - is essentially hoping banks can earn their way out of insolvency. By relaxing accounting rules on mark-to-market and providing just enough capital to keep banks operating, the administration hopes that a rebounding economy along with cheap money will provide enough earnings opportunities for banks to work their way back to health. Johnson points out that this is more or less the approach Volcker took with the banks after the 1982 Latin American debt crisis likely pushed many into de facto insolvency. But Johnson sees three factors that make such a policy succeeding today unlikely:
  • this is a global slump
  • the real economy will probably keep deteriorating, unlike the 1982 recession when there was a sharp turnaround after the Fed lowered rates
  • there are more speculative attacks on banks today
Hedged Bet argued that forebearance was the real Geithner plan after Warren Buffet hinted as much on CNBC last month. It seemed like a plan to emulate Japan's zombie banks then, and it still does now. Let's hope this really isn't the plan.

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