Uncle Academic: "Some economists think bank stabilization ... bad"

Here are two pieces by informed economists who wish Obama well but think the course he's embarked upon with bank stabilization is likely to have bad consequences.  At the very bottom is a link to an article that makes it clear just how toxic the assets the banks are holding may be -- one reason that Galbraith and Stiglitz are worried about the structure of the process by which the banking system undergoes reform -- in particular, why some means has to be devised whereby the government knows what the assets it ends up taking over (if it does) are actually worth.

• James K. Galbraith:  Obama Isn't Doing Enough to Solve the Financial Crisis. An article by Nick Bauman at Mother Jones, 26 Feb 09) offers excerpts from JKG's remarks to the House Financial Services Committee Thursday morning.  (The full text of JKG's prepared testimony is available here in pdf format.)  According to Galbraith:  "[T]he Treasury plan will not achieve its stated goals, and meanwhile risks both triggering inflation and obstructing growth."  He offers an alternatve strategy.  Some pricks to curiosity about details:  
  
1. The current situation is substantially comparable in cause and scope to the catastrophe of 1929 -- far more serious than generally acknowledged.  "We are not in a temporary economic lull, an ordinary recession, from which we will emerge to return to business-as-usual."  The base economic projections relied on are too optimistic.  The path ahead will be "long, profound, [and] painful."
2. The Treasury plan relies too heavily on monetary policy for restoring growth.  But given that interest rates are already nearly at zero, the Fed has little power to affect credit.  Moreover "blocked credit flow" is a mistaken metaphor.  A solution based on false analogy will fail.
3. If carried out, the Treasury plan will preserve, if not exacerbate, a key factor behind the current crisis though its "perverse effect on the distribution of wealth. To guarantee bad assets at rates above their market value is simply a transfer to those who hold those assets. It would enable them to convert those assets, sooner or later, to cash. The plan would thus preserve the wealth of bank insiders and financial investors, while failing to prevent the collapse of the wealth of almost everyone else. I cannot believe that the American public will tolerate this, for very long."
4. Aggressive take-over, restructuring, and strategic sell-off of several major banks is the only solution. 
   
5. Social Security and Medicare are not causes of the current problem.  Curtailing these could do not aggravate the current problem; in fact, enhancing them would help in addressing it.
6. The housing problem is a the root of the crisis.  Obama has a sound approach here, but two additional ones are worth considering as well.
   

• Nobel Prize-Winning Economist Joseph Stiglitz: Obama Has Confused Saving the Banks with Saving the Bankers (Democracy Now, 25 Feb09). '[R]eaction to President Obama's speech from Nobel economics laureate and former World Bank chief economist, Joseph Stiglitz. Stiglitz says the Obama administration has failed to address the structural and regulatory flaws at the heart of the financial crisis that stand in the way of economic recovery. Stiglitz also talks about why he thinks Obama's strategy on Afghanistan is wrong and that Obama's plan to keep a "residual force" in Iraq will be "very expensive…the result of that is the savings that they had hoped won't materialize." On healthcare, Stiglitz says a single-payer system is "the only alternative."'  Listen/Watch/Read:  http://www.democracynow.org/2009/2/25/stieglitz   For additional commentary by Stiglitz, see

• 10 Feb 09:  Interview with Talking Points Memo (here or here).  Addresses 2 questions:  "What’s wrong with the idea of buying the ‘toxic assets’ from the banks? And just what happens if we let these banks go bankrupt instead of continuing to prop them up with continuing bailouts?"
• 6 Feb 09:  Interview with Deutsche-Welle (here or here).  
  
• 2 Feb 09:  "Let Banks Fail, says Nobel economist Joseph Stiglitz" (Telegraph, UK).
• 1 Feb 09:  "Stiglitz Criticizes Bad Bank Plan as 'Swapping Cash for Trash'" (Bloomberg).
• 26 Jan 09:  Stiglitz Commentary: "How to Rescue the Bank Bailout" (CNN)

Here's an article, referenced in Paul Krugman's blog Saturday, that makes it clear just how bad the toxic assets may be that tax-payers are being asked to redeem for big-money players:

• "Time to expose those CDOs" (Financial Times, 26 Feb 09).  An excerpt:

[W]ith t[e ABX now suggesting that triple A subprime mortgage assets are worth around 40 cents on the dollar (depending on the precise vintage), the message from that might almost be too optimistic in relation to some CDOs. So where does that leave the banks? In reality we will not know whether that horrific 95 per cent loss is unusual until the rest of the CDO of ABS are liquidated too. But for my part, I suspect that the saga strengthens the case for financiers now biting the bullet – and conducting some open auctions of this stuff, to get a bit of market price discovery.

Hitherto, most bankers – and policy makers – have vehemently resisted that idea since they feared that public sales would produce painfully low prices. That is a valid fear. After all, there are very few investors in the system right now with any appetite or capacity to take risk.

But in a world where investors already feel utterly terrified by the inability to determine values – and the recovery rate on triple A assets has tumbled to just 5 per cent – conducting an open fire sale might now be the least bad of some terrible options.

After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear; and if it is higher than zero, it might even cheer investors up.

Either way, until investors get some sense of what something might – or might not – be worth, it will be painfully hard to rebuild trust in capital markets and banks alike.

Those American officials who are implementing flashy new “stress tests” of banks would do well to take note.