The passage by Congress of the $700 billion Troubled Assets Relief Programm (TARP) on October 3rd eased, but did not erase, the post-Lehman surge in LIBOR/OIS. The spread apparently stalled in mid-November and remains worryingly high.
How much extra capital, both private and sovereign, will investors require of banks and other intermediaries to conclude that they are not at significant risk in holding financial institutions' deposits or debt, a precondition to solving the crisis?
--Alan Greenspan, The Economist (12.19.08)
There are many who believe that the lax monetary policies of Alan Greenspan in his last term of service contributed significantly to the housing bubble and the financial crisis we now find ourselves in. Some would suggest he was either asleep at the switches (which would be rather extraordinary), doing the bidding of the White House or congress (which would be rather out of character), or too ideologically myopic to recognize the extreme danger and likely outcome of the situation developing. He appeared to be in denial for some time after the scope and threat of the problem became evident. But, in this article for The Economist, he now appears to implicitly accept the realities of the past as he assesses where we are and what is needed to move us forward:
The insertion, last month, of $250 billion of equity into American banks through TARP (a two-percentage-point addition to capital-asset ratios) halved the post-Lehman surge of the LIBOR/OIS spread. Assuming modest further write-offs, simple linear extrapolation would suggest that another $250 billion would bring the spread back to near its pre-crisis norm. This arithmetic would imply that investors now require 14% capital rather than the 10% of mid-2006. Such linear calculations, of course, can only be very rough approximations. But recent data do suggest that, while helpful, the Treasury's $250 billion goes only partway towards the levels required to support renewed lending.
But while recognizing that higher levels of capital will now be required of American Banks (whether it is 14% of assets or higher), and that another $250B of capital is still needed, he looks past the remaining $350B of TARP funds still available and looks to a recovery in the stock market! And his overabundant optimism and ideological faithfulness lead him to assume the market will recover soon enough to be relied upon to do the job.
Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.
Still, he does appear to recognize that recovery of the stock market will likely require stabilization and recovery of the housing market--something a continually unfolding mortgage crisis makes unlikely in the immediate future. And while he more than once admonishes us to timely remove our public capital support to the private sector, he also acknowledges that the temporary infusion of TARP funds was and is important, and the most efficient means of initially addressing the financial crisis and the capital needs of troubled financial institutions.
Another critical price for the return of global financial stability is that of American homes. Those prices are likely to stabilise next year and with them the levels of home equity—the ultimate collateral for global holdings of American mortgage-backed securities, some toxic. Home-price stabilisation will help clarify the market value of financial institutions' assets and therefore more closely equate the size of their book capital with the realities of market pricing. That should help stabilise their stock prices. The eventual partial recovery of global equities, as fear inevitably dissipates, should do the rest. Temporary public capital injections into banks would facilitate this process and arguably provide far more benefit per dollar than conventional fiscal stimulus.
But for whatever reasons--his general uneasiness with public capital injections, perhaps?-- he again seems to take a pollyannaish view of the scope and depth of the crisis, and the time and means necessary to remedy it. From the facts available, it would seem quite unlikely that the continuing unfolding of the mortgage crisis, its effect on the housing market, and the recovery of the stock market will accomodate his optimism and turn the corner in six months to a year. I'm more comforted than ever to know that the pragmatic, non-ideological Ben Bernanke is at the wheel.
http://www.economist.com/displaystory.cfm?story_id=12813430
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