demandside

Plus Arthur Levitt on banks, Jason Tennert on stocks, George Soros on the bailout

Let us not forget the five trillion dollar Bush stimulus package.  Enormous tax breaks, many of them to business backers.  Enormous deficits.  Low interest rates.

Americans invested trillions of dollars in housing that stimulated a jobless recovery and trillions of dollars in losses.  Combine that with the losses in stocks and the extraction of wealth by the commodities bubble, and you have the prescription of the market fundamentalists for recovery.

The idea seems to be let the government bail out all the huge mistakes because we need the financial markets to create a new bubble.

In fact, it was not the crash of the markets, housing, stocks, commodities, that is the problem.  It is the unrealistic and irrational run-up in housing, stocks and commodities.  The crash of these prices is not because of some natural movement of business cycles, it is because they were bid up by the financial sector.

Thus, the financial sector has to be reformed so as not to deal in bubbles.

The inevitable decline in these asset prices is not the mistake the Treasury and Fed must empty the vaults to correct.  It is their bloated value that was the mistake.  Thus the solution is not to empty the Treasury and turn the Fed into a zombie clone.  The solution is to manage the reduction in these values.

Yes, the stocks that bulked up the pension funds and 401(k)s, the houses that were the piggy banks for retirement, the corporate bonds and leveraged instruments that made hedge fund managers the wunderkind of half a decade, need to revert to a reasonable price, meaning a drastically lower price.  Nothing is more poetically just than a financial cowboy who got tens of millions in bonuses now joining the ranks of the unemployed — except perhaps one who is forced to pay back the income he got for ephemeral gains.

Part of that adjustment is coming in the banking stocks.  Here is Arthur Levitt on with Tom Keene, talking about the collapse of the asset values and the likely outcome — nationalization.

LEVITT

Who is going to borrow is the liquidity trap question.  Nobody is going to borrow without the prospect of profit

The cheap money of the early 2000s led to a run-up in housing, then in commodities, along with unnatural strength in stocks, which seemed to get a bounce with each downsizing or reorganization.  All of it was fueled by leverage, cheap money from the Fed.

Did it work?  Well, we didn’t have down years in GDP.  Unfortunately we were eating the seed corn.

Combine that with $5 trillion in government deficits, including over $1 trillion left by W on his way out of town, and the $10 trillion in private borrowing or more, and you have an immense creation of money by borrowing.  It is this which any new recovery program has to counteract.

The Levitt question, who will borrow?  It is the government who must borrow.  First of all, the government can purchase value with its borrowing — infrastructure, education, possibly a halt to the meltdown of the planet’s climate.  This value is simply being brought forward by the borrowing.  Far different from homeowners who took out home equity to buy a vacation or Ski-doo.  Yet is is the second type of borrowing that is favored by the market and by many otherwise intelligent people on Capitol Hill.

One way of repricing these assets is to borrow at low interest rates and pay back with cheaper dollars.  It is a kind of a tax on capital.  And that can be done if the Fed doesn’t get in the way.  Another way is the systematic write-down of debt — mortgages, corporate, public.  But the first and best way is to let the asset prices fall to their natural levels.

The fat cat financial sector is going to shrink by forty percent.  This is a good thing.  If all goes well, public sector health care will grow by ten percent.  This is a good thing.  The capacity to save the planet will grow enormously.  This is a good thing.

What is a bad is believing we need to recreate the unstable situation of the past so as to give ourselves some sort of stability or preposterous prosperity on which to build the future.  Looking for an analogy, we are trying to treat the symptoms as if it were the disease, and recreate the conditions for the disease.

We took a look at banking with Levitt, before we leave, let’s have a look at the markets with chief investment strategist at Strategas Research, Jason Tennert.  Both these gentlemen come to us by way of Bloomberg.

TENNERT

George Soros:

The right and wrong way to bail out the banks, by George Soros, Commentary, Financial Times:

According to reports…, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn worth of bad assets. …

[T]his approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson… The proposal suffers from the same shortcomings… These measures … would … support … banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. …

…

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.

The latter course would avoid recognising and coming to terms with the painful economic realities… The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government … because … banks would … focus on preserving and rebuilding their own equity.

Political realities are pushing the Obama administration towards the latter course. It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well… That is what is leading the Obama administration to contemplate reserving up to $100bn … for the “aggregator bank” solution. …

The choice between the two courses is momentous; once made, it will become irreversible. … President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.

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