Peter to Pay Paul

I do not normally read poetry. Generally I do not go in for over the top sentiment. However, the current environment and the government’s reaction to it reminds me of the Rudyard Kipling poem “If.” It seems to me that the international leaders, the markets investors, and pretty much everyone else should read this poem and remember what it is to be a grown up?

Is this a crisis? You betcha. But as is generally the case it is looking more and more like the cure will be more deadly than the disease.

It has been suggested that if the United States just nationalize the banks by buying a shares in an effort to “fix” the banks and to instill confidence in the banks, much like Buffet has done in the past. Josh referred to an idea a while back in another post.

This is a horrible idea and I attribute the widespread economist support to hysteria and overreaction. It comes down to a basic reality; a government entity bears little to no similarity to a common place investor. Whereas an ordinary investor has finite resources and time which she uses to profit, the government arguably has infinite resources, has a much better survival rate, and its main purpose is not profit. So thinking that the government could “act” like a common investor is ridiculous.

The next question is whether this would necessarily be a bad thing. After all, capitalists are bastards and government is good. Except we have already tried a variation of that strategy: Fannie Mae and Freddie Mac.

An organization that existed with the government’s approval and oversight, but supposedly without its funding or the benefit “guaranteeing” its loans, it was an organization dedicated to creating a secondary market for loans with the hope of lowering the cost of borrowing money to expand home ownership. That would have been great, except for the government’s excessive exuberance in pursuing that goal contributed to the government adopting a ton of loans that defaulted. While there was a statutory disclaimer that the government would not guarantee those loans, Congress ultimately did bail out Fannie and Freddie, which had the same practical effect as a guarantee.

While the preferred shares the government will get would technically prevent the government from having an active management shares, the government’s past history and all of the contractual requirements placed on banks for accepting this money reveals that this distinction is a mirage at best. The government is getting its hand in not only regulating, but in managing banks. This will lead to the nation’s banks having a Fannie/Freddie like crisis in a few years.

An inflow of cash through governmental investment could conceivably stabilize the market in the short term (1-5 years). What is driving the precipitous drop in the market, similar to the Depression, is the slow down in the capital market. No capital, no expansion, no jobs, etc., and thus the connection to the fear of a widespread recession. More money infused into the banks would open up the credit markets, and voila, disaster is stymied.

But what happens during the next crisis, when the fundamental issues are still there, undiagnosed and unfixed? Only now, the government has less economic resources, a further depleted workforce due to boomer retirement, and increased burdens stemming from its social welfare services. The government will be in a much more difficult place to do anything to combat the problem then, and will probably fall back on the tired platitudes and half baked Hail Marys. Whereas now we are in a position to avoid a Depression but fix the inherent problems, in a couple years we won’t be that lucky.

However, I do not think nationalization of banks will fix the economy even in the short run under the idea of “too little, too late.” If a government is going to intervene, especially in matters of confidence, it needs to do so quickly and effectively. The world wide response has been neither.

While the nations’ governments have recently promised money and there was significant growth in the stock market, the one did not necessarily cause the other. Two weeks ago was one of the worst weeks for the global economy ever. After such a steep drop, the mere absence of bad news would be enough to cause the markets to rebound. Add in that the governments did do something and stated a big number (granted without a lot of details), and the markets were due for a rise. I don’t think it will last long term. And today was another pull back.

So short term prediction is this, and it is something we are already starting to see. Given the world market’s voracious appetite for American debt and their enabling attitude, the world market is going to have hard hit recession (hardly a shocker). Unfortunately for us, world investors will back out of the emerging markets because emerging markets are not trusted, driving the dollar up in value. So now we have to pay off our debts using more expensive dollars and exports go down, exacerbating unemployment while minimizing inflation. The stereotypical response, decreasing interest rates, won’t help, because people are so petrified of the debt system and don’t trust it that loans won’t go out at the rate we need and unemployment and decreased production will persist. Given that the stock market grew based on playing popular perception as opposed to market fundamentals, the exacerbated growth of the 90s and early 2000s, will be met with exacerbated drops based on hysteria.

The interesting things to watch will be to see how Europe responds, given their fragmented economic system (one central bank, many treasury departments, many different views on how to do things with mirrored circumstances to the US). Will this be a serious blow the Union? Will investors break the “playing the table” strategy and start playing their cards? And will the United States begin to address the fundamental problems, or merely stick with the well known platitudes that make great copy, but crappy solutions?