One Conservative's Proposal to Save the Banks

Larry Kudlow proposes a way to save the banks, and it is basically to do nothing b/c they are in the process of saving themselves. This would be nice if true. The real purpose of his story is to try to preserve any long-term profits from the "toxic" assets held by these banks for private investors.

Kudlow writes: "Out of the blue, bank stocks mounted an impressive rally this week, jumping nearly 40 percent on the S&P financial list. One after another, big-bank CEOs like Vikram Pandit of Citi, Ken Lewis of B of A, and Jamie Dimon of JPMorgan are telling investors they will turn a handsome profit in the first quarter, their best money gain since 2007." ..."When the Fed loosens money, and short-term rates are pulled well below long rates, banks profit enormously from the upward-sloping yield curve. This is principally because banks borrow short in order to lend long."..."Now, turn the clock back to 2006 and 2007. In those days, the Treasury curve was upside down. Due to the Federal Reserve's extremely tight credit policies, short-term rates moved well above long-term rates for an extended period, and that played a major role in producing the credit crunch. Since interest margins turned negative, the banks had to turn off the credit spigot, and all those exotic securities -- like mortgage-backed bonds and various credit derivatives -- could no longer be financed."

Kudlow's story would be a nice one if it were true. Where is the evidence for "high" interest rates before the financial meltdown? The Fed consistently lowered rates since 2001, fueling the housing bubble. The Fed window is essentially at zero, so banks are bound to make a profit IF they lend. But with the economy contracting at 6%/year, who is going to borrow? The stimulus package is necessary to try to create some demand.

If banks were to start significant lending in the next six months, Kudlow's analysis might be correct. More likely, this is a recipe for anemic Zombie banks to continue dragging along through 2009. The real purpose of Kudlow's suggestion is to preserve the long term profits of these toxic assets for the banks and private investors.

The problem with all the various TARP plans is that the government cannot price these assets: either the taxpayers get ripped off which is politically untenable, or the banks face such large write-downs that selling these assets makes them insolvent anyway. What is probably inevitable, and what the Fed should do soon, is to buy CitiGroup (they could have had it for $6b last week, and can still get it for 10b). They would then own the assets. They could strip out the non-performing assets and put them into a Fed holding company (bad bank), then stuff cash into the vaults until the bank is guaranteed solvent. They would then hold an IPO of the much smaller bank, which would raise more capital than the Fed put into it. The Fed can afford to hold these toxic assets for many years, and this plan avoids pricing them specifically: the aggregate price would be cost of recapitalization of the bank. The Fed would probably profit long term from these assets, so the taxpayers are net close to even. This is not a case of the Fed "picking winners and losers"; the market has already done that. The downside is that money would flow to the new bank, putting other banks at risk. But so what? One good big bank would return investor confidence, and if necessary the Fed could do the same thing for B of Am. and then Wells Fargo. The bankers have so badly mismanaged their businesses, they have no right to any long term profits from these bad assets. These banks control about half the assets of the entire system; if smaller banks go belly up, it doesn't matter: hundreds will anyway.

Tonight's Debate

In tonight's second debate b/n Barak Obama and John McCain, many pundits have opined that McCain needs to "take the gloves off" and go after Obama. This advice misses several key aspects of the race at this point. According to the polls following the 1st debate, the public really liked Obama's attempts to emphasize common ground ("John is right") and his even temper. McCain appeared to be a grumpy old guy who held his younger adversary in contempt. If McCain levies personal "character" attacks at Obama, the public is likely to take it badly.

McCain's potential lines of attack have already been partially innoculated by Obama: if McC brings up Rev. Wright, that issue has mostly been discussed. Obama's association w/Bill Ayers has been covered recently, and it is unlikely that the audience will have their opinions changed by this line of attack. It has also been suggested that Obama be attacked over his comment about "air-raiding attacks that kill civilians" in Afghanistan. However, if McCain raises this attack it will give Obama a chance to explain the context of the remark: he was stating the case for more troops on the ground in Afghanistan in order to avoid reliance on air strikes that necessarily cause more civilian casualties. Giving Obama that chance to explain the context behind these smears simply undercuts the GOP's ability to use them. It's better for McCain to let the attack ads carry the sleazy innuendo while he keeps to a higher road.

On the other hand, McCain's supporters seem to think that there are no opportunities for serious attacks on Mac. If Obama's character and associations are attacked, he can counter with Mac's close connection to Phil Gramm, who is probably more responsible for this financial meltdown than any other single person. Do you think people are more concerned with a radical bomber from 40 years ago (and never killed anyone) or the financial crisis that is wiping out their retirement accounts? Obama could even bring up Ollie North, who's actions supporting a terrorist organization no doubt resorted in far more murders than anything Bill Ayers did. But I don't think any of this will come out in the debate, because the stakes are too high in offending the public. People are scared right now about the economy, and the candidate that seems more steady, more calm, better able to address the public's concern about protecting the middle class on health care and social security, that candidate will win the debate and the election.

Does anyone seriously doubt who that candidate will be?

McCain's Box

OK, I'm getting back on the blogging train, and this time I am making a commitment to regular posting and to connecting with other bloggers.

I call this post 'McCain's Box' because I think McCain is in a box as far as his campaign strategy goes. McCain's greatest strength is his ability to appeal to swing voters, to those moderate unaffiliated or conservative Democratic voters. But every time he repositions himself as "not a scary conservative guy" he risks alienating the GOP base: the social conservatives whose participation elected GWB in 2000 and even moreso in 2004. Yet every time he throws red meat to the faithful, he shows himself as the kind of scary conservative that swing voters don't want in this election cycle. This paradox hasn't become so apparent thus far because we are still in the "silly season" when most people aren't really paying attention to the campaigns. Come September McCain is going to feel the pressure of walking this razor's edge. For example, many voters don't understand that he is a lifelong opponent of abortion rights. When he is forced to pledge allegiance to the pro-life position this fall (it will happen), moderates will notice. When he states his reasonable position on immigration reform, the hard-liners in his party will voice their disgust. While he might be successful in triangulating these issues by running a nasty negative campaign combined with populist economics, the most likely result is that he depresses turnout among core GOP true-believers (even a few percent in Va. or Fla. would be a disaster for him) AND fails to attract enough swing voters.

Agree? Disagree? Discuss amongst yourselves :-)