Stabilization
President Obama and his Administration are pursuing policies based on the assumption that the structural dysfunctions in our financial system can be identified and corrected and the economy stabilized in response to Federal government initiatives. I admire the Administration’s positive attitude even as I question their analysis.
The assumption underlying this scenario is that at least half of our problems are psychological in origin, caused by the lax cluelessness of the Bush Administration and the collapse in confidence during the September meltdown. The Obama Administration has done a terrific job of applying a full-court press in the media, appearing everywhere all the time – Bernanke and Obama on 60 Minutes, Obama on Jay Leno and Face the Nation, Geithner on both Meet the Press and This Week with George Stephanopolous the very same day.
This media blitz unquestionably influenced the markets during the last three weeks for March. Some believe the bull is loose again. But there is as yet no evidence the housing market has stabilized. Every index shows relentless decline month after month. Average home prices have now fallen almost 40% from their peaks in 2006.
The Obama Game Plan
Here is how the stabilization game plan is supposed to unfold. The Federal government will attack the banking / credit / housing depreciation crisis, universally understood to be the root of our financial crisis, by assisting the banks in unloading their impaired assets. These so-called toxic assets have been renamed legacy assets, a word with far better connotations. The new word will help. In any case these assets – toxic or legacy – cannot be sold in a free market today because no one wants to buy them.
The Obama Administration will benefit from changes made by the independent Financial Accounting Standards Board (FASB), which decided on April 2nd to change the “mark-to-market” accounting rules that had so devalued the toxic/legacy assets. These assets can now be valued according to what they would fetch in an “orderly market,” rather than what they have recently sold for in the real market. This should, in theory, make it easier for banks to buy, sell, or hold them.
The key play in the Administration’s game plan is to create a public / private investment plan for these toxic / legacy assets. Hedge funds, previously cast in the role of villains – vehicles for the irresponsibly wealthy to amass even more obscene wealth – will ride in like cavalry to the rescue. Sharing profits equally but risks unequally, they will partner with Treasury. The taxpayers will take 93% of the risk, which, as Timothy Geithner points out, is better than 100%, and receive 50% of the profits, if any. If the toxic / legacy assets decline in value, the private investors could be wiped out, but the taxpayers could suffer even larger losses in absolute dollar terms.
Obama has also announced substantial Federal programs to relieve homeowners and small businesses, and the Federal Reserve has announced a massive program to buy corporate debt for the first time.
Many people believe these coordinated actions, taken together, will have a powerful effect on the debt markets. Once new debt can once again floated and banks provided with a way to unload their toxic/legacy assets, the Obama playbook says, the extension of credit will gradually return to normal and the economy will begin to grow again, possibly even this year. Restored confidence in the U.S. will restore confidence elsewhere, and the U.S. can resume its role as the locomotive of the global economy, pulling Europe and Asia and the developing world back towards renewed prosperity. Or at least that’s what the Obama game plan says will happen.
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