THE PLANK MARCH 8, 2009
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In light of the week's terrible economic news we asked Simon Johnson, a professor at MIT's Sloan School of Management, a Senior Fellow at the Peterson Institute for International Economics, and co-founder of Baseline Scenario, if there were any reasons, any at all, to feel hopeful. Here's what he wrote.
The most dangerous thing in any economic crisis is denial. West European countries are still refusing to come to grips with the new (downward-looking) realities in East-Central Europe and what that means for their banks and their fiscal solvency. Most Asian countries have yet to wake up to the implications for their export sectors, their real estate markets, and their social stability. And almost no commodity producers in the Latin America or Africa fully comprehend how this gathering storm will affect either elite pocketbooks or the masses of already desperately poor.
Since President Obama's election, the degree of denial in the United States has fallen dramatically. At his press conference on February 9th the President said:
If you delay acting on an economy of this severity, then you potentially create a negative spiral that becomes much more difficult for us to get out of. We saw this happen in Japan in the 1990s, where they did not act boldly and swiftly enough, and as a consequence they suffered what was called the "lost decade" where essentially for the entire '90s they did not see any significant economic growth.
This was an accurate and remarkable statement of our predicament--remember that U.S. presidents usually choke on a word as mild as "recession."
Since then, of course, we've seen a fiscal stimulus which--while not ideal--is quite an achievement in this political system. We're also seeing the development of an approach to housing that represents a major step forward. But there is one major aspect of denial still remaining: the scale and nature of our banking difficulties.
Until this week, leading officials were downplaying the problems. Chairman Ben Bernanke's and Secretary Tim Geithner's recent appearances on Capitol Hill appeared designed to be reassuring, but few were convinced. The line from the White House was: We can't do more at this time, because there wouldn't be support on the Hill--particularly in the Senate. The market perception of default risks in and around major banks has consequently risen sharply, suggesting that we are heading for a sudden showdown.
Yet, just as the future seems most bleak, some glimmers of hope shine through. Leading figures in the Senate are making it clear that they see the need for urgent action on major financial institutions and would support the deployment of sufficiently massive resources to that end. Senator Kent Conrad, chair of the Budget Committee, has been making this point at least since January; he was joined last week by Senator John Kerry, chair of the Foreign Relations Committee. And, most concretely, Senator Chris Dodd--chair of the Banking Committee--has just introduced legislation (at the behest of Bernanke, Geithner, and Sheila Bair, the head of the Federal Deposit Insurance Corp.) that would substantially increase the resources available to the FDIC. This falls easily into the category of "sensible preparations that should have been in place long ago."
There are no magic bullets for this situation. Whatever happens, the financial situation will be difficult, and we cannot expect to turn any corners soon. But we should take some reassurance from the sight of leading senators working closely with an administration that may be coming to its senses. We may finally be done with denial.
33 comments
Excellent piece, Mr. Johnson. The Bush denial has been replaced by the Obama acknowledgment. But his people, Timothy Geithner most especially, have been slow in dealing with the banking crisis. The banks need to be recapitalized and this needs to happen now. Sure, it will be politically unpopular That is what leadership is for - to make a hard case and take it to the public. The FDIC problem also has to be dealt with immediately.
- liberal reformer
March 8, 2009 at 12:29am
Excellent indeed.
- roidubouloi
March 8, 2009 at 1:49am
Agreed, excellent piece. I'm no finance guy by any stretch, but I'm not convinced that the Obama people have actually been slow or failing to understand, given the real-world constraints they are forced to live with. The nationalization ideas some have been pushing might be the right answer, if not for the fact that the need for Congress to pass legislation first makes it a non-starter. In the time that it took for Congress to debate legislation, the total market capitalization of the entire banking sector would drop to essentially zero. (Would you bet against a cloture vote in the Senate? It would not even have to fail, because asking for the vote guarantees a day-plus delay.) . Likewise, the public appears to be ready to kick itself in the nuts to spite "the bankers". And the markets appear to be ready to panic at any excuse.
- JEFF FREY
March 8, 2009 at 1:51am
I don't think the politics are intractable, Jeff Frey. Obama needs to stand up and tell the public that: Regardless of the losses that have been incurred, the United States cannot and will not allow bank deposits to default, to go unpaid when due, and that the Federal government will therefore stand behind all bank deposits; that the question for the nation is whether bank investors should be bailed out too when that is not necessary in order to bail out the banks; that the answer is no; that just like the many thousands of Americans who have suffered losses of wealth, bank investors must bear their full share of the losses caused by their own banks; that he is submitting to the Congress legislation to give us the tools to do this expeditiously, fairly, transparently, and in the manner that is at the least possible cost to the taxpayers.
Then stand back and watch the public back every single legislator into a yes vote in no time flat. Of course, you have to have negotiated the deal with the critical players in Congress in advance, but that too is doable.
- roidubouloi
March 8, 2009 at 4:13am
Very funny Geithner opening skit on Saturday Night Live tonight!
- JEFF FREY
March 8, 2009 at 4:39am
roi, I see your point and your general arguments have been persuasive. The problem I see is that the moment you say you are going to nationalize banks and wipe out investors, there will be a run on ALL bank stocks -- investors will be wiped out before the banks can be nationalized and any banks that are solvent are likely to be hit as well. The second problem is that if you need to change any laws to do any part of the task, the few days it will take to get anything past the Senate will have the same effect. One can argue that the investors in the bad banks are just getting what is coming to them, but it is hard for me to see there not being a lot of collateral damage (so to speak).
What the point of all of the "stress test" talk and incremental measures are, I think, is to lay the foundation for people to believe that when they go after some banks, the others will have been found to be viable (or else, like Citi, we'll own them already piece by piece).
- JEFF FREY
March 8, 2009 at 4:54am
I might have been more clear in the first post. I think the constraints may be as much practical as political.
- JEFF FREY
March 8, 2009 at 4:56am
JF,
The problem you describe is non-trivial, although I don't under the circumstances see any reason to be concerned about the value of bank securities other than the impact on deposits and interbank credit. For that reason, ideally the Feds should be in a position to declare guarantees first, so that the patient is stabilized before they start to operate. But that might very well require legislation. I don't know what authority the FDIC and the Fed already have in this regard. It is the gap between where we are now and the ability to take hold of the system that poses real risk absent the cooperation of Congress -- meaning immediate action, nothing less.
It is possible that Geithner and company are actually choreographing something like this even while they give the appearance of dithering. It occurs to me that the "stress test" may in fact be intended to fail the vulnerable amongst our biggest banks so that they can be taken over by the FDIC under existing authority. This might explain the preparation of adding $500 billion to the FDIC's coffers "contingently." The top 20 banks account for about 45% of total US bank deposits of $7 billion. So, if they can do triage on the top 20 and either declare them sound or fail and seize them, they will have taken a big step towards stabilization and cleared away a lot of the mystery about who is solvent and who is not (except for that other problem of derivatives, but that would not affect banks outside the top 20 as it is doubtful that any of the rest participate in that market). I hope this is what they are doing and, if so, it is a pretty clever way of dealing with the problem you describe. I would guess that if they took care of the top 20, it would not be that hard to go to Congress for a pre-pack legislative solution to the rest without causing a panic. The one big problem I can see with this scenario is that with modest to small size banks that fail, the FDIC does not guarantee their uninsured deposits but has them assumed by a solvent institution so that there are no losses. With our biggest banks, there isn't going to be anyone to assume them. If the FDIC or the Fed cannot guarantee them and there is no one to assume them, the melt-down risk disappears.
Or, maybe they are using the stress test to scare the crap out of Congress in order to get fast action. Dunno. I understand the financial solution; I don't have a grip on the complex of regulatory, legislative, and political hurdles to get there. I don't doubt that they are formidable. If Obama, despite the seeming lack of action, pulls that out, then I would say we have elected the political genius we hoped for and need at this juncture.
- roidubouloi
March 8, 2009 at 10:27am
The system can be stabilized by making people less fearful, not more so. Provide unemployment insurance without an end date. Help small business remain solvent. Encouraging massive job retraining into areas where jobs are available happened in Pittsburgh in the 80's, folowing the collapse, because of global pressures, of the steel industry. Pittsburgh now has a stable real estate market, a largely recession proof economy and relaitively low unemployment. All without massive Federal bailout. Scaring people helps destabilize the economy further and makes them swallow Obama's real agenda which is to expand government control over the economy.
- r-ennis
March 8, 2009 at 1:02pm
Wake up, people: it's far worse than anyone who knows anything has the guts to admit:
Item: An upper-middle-class woman in St. Louis told her husband over the weekend that she has decided to hold off buying another pair of shoes. Wisely, hubby scooped up the kids and moved in with his sister.
Item: Divorce lawyers in some parts of the country, stung by their clients' newfound "it's cheaper to keep her" philosophy, are switching to well vodka and domestic, mass-produced beer.
Item: My buddy over in Shipping has a neighbor whose brother's chiropractor told him that, in one New Mexico cul-de-sac, parents have begun eating their young.
Item: Students in $30,000+/year private universities are now showing up for 9 a.m. classes in record numbers. One was even overheard using the word "please" while speaking with a cafeteria worker.
Item: Worried by declining attendance numbers at this year's Spring Training, MLB commissioner Bud Selig announced that the 2009 World Series title will be raffled off for charity.
Item: In a brief, unscientific survey of Craigslist postings, the price of a "car date" has fallen south of $60 in some areas.
Item: Mexican officials have declared "open season" on tourists, hoping to stem surging unemployment numbers among drug gang rank and file.
Item: Winnebago's fastest-selling RV is the just-released Tom Joad I, which features a leaky corrugated tin roof, frying pans hanging from the sides, and a chicken.
Item: Starbucks will close even more outlets, including five at a single Manhattan intersection. Starbucks also revealed that the mermaid will henceforth sport a sensible haircut as well as attire appropriate for job interviews. The top-selling CD at Starbucks last month was "Our Favorite Dirges," featuring James Taylor, k.d. laing, Elvis Costello, Norah Jones, et al.
Item: China has decided to put Tibet up for sale, on eBay. Cash-strapped international "Free Tibet" organizations have begun offering their members tote bags in exchange for help in meeting the $25,000 asking bid.
Item: In a sure sign of an economic downturn, Americans are flocking to the movies in record numbers. Often, the theaters in question aren't even open, in which case patrons simply mill around outside in the rain, Twittering or what not.
Item: Petty theft always spikes during a recession, and the current slump is no exception. Dildoes and butt plugs are disappearing in many stores, thanks to patrons' "Look Ma--no hands!" chicanery. Pet store owners also report that canaries are flying off the shelves.
Item: Americans are cuttting back and making do. Upcoming Hollywood sequels include "The Sixth Seal," "The Fifth Sense," "Four Easy Pieces," "Fantastic Three," and "2 Women." David Letterman will begin phasing in a Top Nine list on Tuesdays. Judeo-Christian theologians now emphasize adherence to the Seven And A Half Commandments.
- williamyard
March 8, 2009 at 1:14pm
roi,
Your scenario for the stress test sounds completely plausible. I hope they are following some such clever scenario. I wish I knew for certain. I think that, whatever they are really planning, they can't show any of their cards until they are ready to play the hand, and the posture they need to take now will look like dithering even if they are not dithering. We find out if it really was when they act (or not).
I also think we have to be very concerned about the investor's equity in any banks that are actually solvent. They should not be wiped out accidentally.
- JEFF FREY
March 8, 2009 at 1:24pm
yard, fantastic.
- blackton
March 8, 2009 at 1:44pm
r-ennis, all good suggestions.
JF, I hope along with you that it only appears that they are dithering while they get ready to play seriously. I don't see any reason why solvent banks should be injured if a little bit of care is exercised. The key really is to grab hold of the whole system at one time so that there are no out of control side effects. You then release banks back to the market as soon as they can be declared or rendered solvent and sound. That way, you don't get runs at solvent institutions out of fear.
- roidubouloi
March 8, 2009 at 3:15pm
"It is possible that Geithner and company are actually choreographing something like this even while they give the appearance of dithering."
Waiting for the key players and the rest of the country to scream for nationalization is to Treasury and Obama Co's benefit. They have to conserve energy for where it matters - saving the economy.
Politically, the wait saves and time and energy in the long run. No one is taken by surpise when Dad's retirement fund is nuked once and for all, no hope of it ever coming back on five years, etc.
If everyone is on board up front, the hysteria factor can be contained to the usual suspects who will remain hysterical until further notice no matter what happens.
R-ennis - you'd have so much more credibility if you'd acknowledge the specificity of emergency of we are in and exactly what took us here instead of relying on tired paranoia about Obama's motives. If the masters of the economy hadn't run it in to the ground in the first place, the government wouldn't have to step in to stave off a depression. This is very basic, obvious stuff.
Obama leans left, the country voted him in and he's entitled to flavor the rescue in the ways his party presents. Americans are welcome to vote against his initiatives by petitioning their representatives and I'm sure they will - between Bush's 180 billion for corporate pig farmers, 600 billion to big pharma, etc, etc etc I think they've seen enough of government control of the economy to last a generation or two at least.
There is no cloak and dagger, secret intentions, what have you. If you think Obama longs to "control" the economy, whatever that means, you just aren't paying attention. He has better things to do.
- Wandreycer1
March 8, 2009 at 5:37pm
From the Obama/Socialist thread, his words to the NYT:
"A. Well, I just think it’s clear by the time we got here, there already had been an enormous infusion of taxpayer money into the financial system. And the thing I constantly try to emphasize to people if that coming in, the market was doing fine, nobody would be happier than me to stay out of it. I have more than enough to do without having to worry the financial system. The fact that we’ve had to take these extraordinary measures and intervene is not an indication of my ideological preference, but an indication of the degree to which lax regulation and extravagant risk taking has precipitated a crisis."
- Wandreycer1
March 8, 2009 at 5:52pm
In reply to wanreycer, what makes you think I do not acknowledge Bush's culpability? But Bush is not the only culpable figure as you know or at least should know. Fannie Mae and Freddie Mac actions had as much to do with Democratic as Republican failures to read our economic health realistically. I voted for Gore and even held my nose and voted for Kerry. I am a Clinton centrist.
Both parties are guilty of pandering to the American people and offering them a free lunch. Obama is not only no exception. Obama is the undisputed master of such pandering. However, I have faith in the enterprising spirit of the small group of Americans, mostly of relatively humble means, who still believe that this is the land of opportunity and will see this crisis as the great opportunity it is. They will prevail; not the massive government bureaucracy this group of radicals, temporarily in power, envisages for the rest of us.
- r-ennis
March 8, 2009 at 6:31pm
First paragraph: I totally agree
Second: mindless hysteria.
- Wandreycer1
March 8, 2009 at 8:07pm
Look r-ennis, I'm as afraid of tryanny as the next guy - you're just not looking at it. What you're looking at is a country coming to something resembling a consensus. This is all in motion. But I think imprecision and simplistic, detreministic hyperbole are toxic to the country's health. I just can't tolerate it anymore.
- Wandreycer1
March 8, 2009 at 8:40pm
Below is a campaign contribution profile for Conrad, Dodd and Kerry. You can't help but wonder how worried they might be now if they don't succeed is resuscitating the Big Buckmeisters. They might be forced to have bake sales and car washes to fund their next election
Kent Conrad:
Lawyers/lawfirms $1,030,400
Insurance $821,200
Healthcare industry $606,400
Securities & investment $595,400
Lobbyists $417,300
Chris Dodd:
securities & investment $5,746,800
Lawyers/law firms $2,841,100
Insurance $2,134,100
Real Estate $1,838,700
Commercial banks $1,283,500
John Kerry:
lawyers/law firms $26,228,600
business [misc.] $7,707,500
securities & investment $6,381,900
real estate $5,555,800
healthcare industry $4,623,100
finance [misc] $2,805,200
- iambiguous
March 8, 2009 at 8:56pm
"What you're looking at is a country coming to something resembling a consensus." We must live in different countries! Obama's stimulus and proposed budget are the most divisive pieces of proposed Federal government action I have ever seen. And even those who claim to trust Obama are highly dubious.
If you are as afraid as tyranny as you say, you would also, at least, be dubious. What happened to all those people with "Question Authority" bumper stickers on their cars? Do these sentiments only apply when the occupant of the White House is a Republican? How mindless is that?
- r-ennis
March 8, 2009 at 9:33pm
Sorry, r-ennis, I think the Vietnam and Iraq wars were a wee bit more divisive. Unless I have missed the protests in the street over the stimulus.... You are being unbelievably hyperbolic. (on a super-galactic scale!)
- JEFF FREY
March 8, 2009 at 11:50pm
Maybe this just reflects my economic illiteracy, but I don't understand this concern of JF's: "In the time that it took for Congress to debate legislation, the total market capitalization of the entire banking sector would drop to essentially zero." Why is the value of bank *stocks* important? As I understand it, companies issue stock as a way of raising capital, but if the whole point was a government rescue / takeover of the sector, then there would obviously be no need to issue any new stock for that purpose anytime soon. (I doubt they're planning to anyway.) As to existing stock, that's a bunch of pieces of paper of X value that are already in the hands of a bunch of investors. X represents what other people are willing to pay for those pieces of paper at a given moment. What difference does it make to the health or viability of the banks if X drops to nothing? That would mean that nobody wants to trade their stock anymore (pending the action in Congress that JF is hypothesizing), but it doesn't affect their *deposits*, does it? Isn't a "run on the banks" an expression of concern about deposits, not stock values, and wouldn't pending action in Congress to prop up the banks in fact *increase* confidence in the safety of deposits rather than undermine it?
As I say, I'm not exactly an economic savant, so if I'm missing something I'd be happy to be set right on this.
- JSmith125
March 9, 2009 at 12:16am
JSmith - it's all about CONFIDENCE. That was a given in the old economy. It's missing now. Without confidence, no one lends, no one spends, no one borrows, no one invests, no one has children, no one hires.
Everything that Team Obama does now has to have as its primary goal the restoration of confidence in the future. Not transformation, not redistribution. Just confidence that the wheels will not fall off.
Rahm's got it wrong. A crisis is not an opportunity. It's a f*cking crisis, and it needs to be resolved before one even thinks about "opportunities."
.
- teplukhin2you
March 9, 2009 at 1:36am
JSmith, suppose that you own stock in bank, and legislation is introduced in Congress to give the Feds expanded authority to take over and nationalize banks, and Congress is told they need to fast-track it because they have to act now, beyond what they can already to at present. For the owners of banks that really are insolvent, losing their stake via the share price dropping to zero or by nationalization is six of one, a half dozen of the other. But what if the bank you own shares of is actually solvent? As tep noted above, would anyone have the confidence to buy your bank's stock in the run to sell off while you can still get something back? The good will get dragged down with the bad.
My point is that any takeover that is on a large scale has to be done suddenly, comprehensively and without warning, and also be seen to solve the problem. Otherwise, panic can be the result. Not that I am any economic savant, but that's my argument.
- JEFF FREY
March 9, 2009 at 2:44am
Jeff - in the short term, sure, some good banks' shares will swoon, but you can't heal the patient without a reality-based diagnosis-- and in this case, without surgery as well. A billion here, a billion there won't do it. The banks need to be recapitalized, and that requires wiping the ownership slate clean. ie wiping out existing owners. Bankruptcy, nationalization: call it whatever you like, but the ownership structure needs to change so that new equity can be created with new capital, at a much lower valuation than the present one.
- teplukhin2you
March 9, 2009 at 4:47am
OK, thanks, but here's a follow-up: The federales have some kind of authority to suspend stock trading, right? So, could the administartion just suspend trading in bank stocks at the same moment that it makes its move, and then maintain the hiatus (kind of in the spirit of FDR's "bank holiday") while the legislation we're discussing went through Congress on a fast track?
- JSmith125
March 9, 2009 at 5:33am
I don't think coming to a consensus means there is no division, but I agree - we must be living in different countries indeed R-ennis, everyone I know of either party trusts this guy and the polls agree. His policies are like having to change the valves on a crashing airplane. He's not tryrant, the idea cracks me up. He's a guy with a huge pile of steaming, flaming poo thrown in his lap by the geniuses on the right.
But I do honestly salute your vigilence and passion - we always need it and I know it helps the final consensus we are coming up with to be more equitable and thoughtful. I shouldn't use the word mindless when commenting on your posts because they never are. Lets reserve the right to call each other hysterics though ;) That's too good of a word.
I supported Bush's wars BTW, I lean pretty right on foreign policy - too bad Bush sucked at it so badly. I also supported his work on AIDS which was peerless. The rest of his work speaks for itself.
But I find the idea of anyone supporting Republican economic policies to be manifestly absurd and that's what drives me nuts. The utopianism is blinding and the ideal has never and will never exist - which we just got done proving once and for all (Bush had spent the surplus and tripled the debt by the time he was re-elected, with 90% of Republicans voting for him - that also speaks for itself). Reagan had a point, 90 percent was too much, but once that was done it was DONE. People never moved on, its not 1984 forever. The rest of it just leads to the same place every time - broke, bubbles, incompetence, waste.
I'm about what works and by works I mean creates the most stability and opportunity for the most people, not what creates millionares - although I support that as well, just not at the expense of everything else. And it my lifetime I have never seen Republican economic policies do anything but demolish the middle class and everything they come in to contact with (except billionares bank accounts which does not count as working for me).
- Wandreycer1
March 9, 2009 at 10:14am
Good question, JSmith. I don't know the answer. If legal, it seems like it might work.
- JEFF FREY
March 9, 2009 at 12:23pm
"I supported Bush's wars BTW, I lean pretty right on foreign policy - too bad Bush sucked at it so badly."
Obama's handling of this economic crisis parallels Bush's early handling of AQ and the terror crisis. Regardless of what one thinks of its merits, a pre-existing agenda has been allowed to displace the laserlike focus on the threat at hand that Americans perceive. Fwiw, I support single payor and I supported the overthrow of Saddam via US military intervention. But an administration can only do so many things and do them well. We could not rebuild Iraq while fighting two wars simultaneously. I do not believe Obama can push through his vast agenda while fighting the war against collapsing economic confidence.
The man needs to focus on the crisis at hand. That crisis is one of rising economic insecurity. Only those parts of the transformational agenda that will have a major, widespread, immediate impact in terms of reducing economic insecurity should receive vast new funding and bandwidth now-- that means helaht insurance expansion, ie shifting as many people as possible to the same health insurance plan that Congress gets. Start with the autoworkers and the employees of the auto suppliers. Federalize their employers' health insurance and pension obligations ASAP. Far more effective than yet more 11-figure cash infusions that will not help restructuring or ease workers' insecurity.
- teplukhin2you
March 9, 2009 at 12:38pm
Hope editors seal this post and entire comment thread for posterity.
- CAMtwo
March 9, 2009 at 2:22pm
It's pretty easy to "accept" the recession when you can blame it on your predecessor - and you can us it as a cudgel to beat the hell out of the opposition into passing the biggest spending bill in American history.
We'll see how eager Obama is to "acknowledge" the recession 6 months down the road when he's got no one to blame but his worthless policies.
- jwl2672
March 9, 2009 at 2:38pm
Wow, what a deceptively crappy title. Here I was expecting to read about some leading indicator with positive numbers, unemployment rates less than hideous, or manufacturing numbers increasing. Instead, I get some worthless muck about how great Obama is in "acknowledging" the poor economy and that we're all going to be just fine thanks to the great Obama turning his EYE towards this problem.
Unbelievable the depths TNR has sunk.
- jwl2672
March 9, 2009 at 2:41pm
jwl - buy PALM or S or NFLX. There art thou happy.
- teplukhin2you
March 9, 2009 at 3:07pm