Sunday, October 12, 2008

Weekend Roundup

As I write the US futures are pointing to a higher open (however, if we've learned anything this week, we know that the futures can swing wildly) on news that the EU will be taking equity stakes in European banks and injecting more cash into the banking system.

So the big question is -- Will it work? Well, not to sound too political, but I think the answer is a definite maybe.

1) Banks are likely to resume interbank dealing because the European governments will be stepping in to guarantee those loans.

2) European banks are more likely to survive as a result of the direct injection of capital.

However, I'm not convinced that the banks will feel compelled to suddenly start lending again. First a little primer on how banks work: A bank takes your $1 that you deposit and lends it out 10-30 times to borrowers. The banks assets are those loans and they have to keep their capital ratios inline either by lower their loans outstanding or increasing capital.

While I think the banks are publicly saying that a plan like the EU plan will improve their capital ratios and enhance their ability to lend, I think that the reality is that the banks are still concerned about a huge portion of their asset base. The banks are likely to remain unwilling to extend new credit until they feel comfortable that their assets are going to stabilize.

In a stunning turn of events, it seems that the US policymakers have reversed course on the $700 billion bailout according to this article.

"Two weeks after persuading Congress to let it spend $700 billion to buy distressed securities tied to mortgages, the Bush administration has put that idea aside in favor of a new approach that would have the government inject capital directly into the nation’s banks — in effect, partially nationalizing the industry.

The Treasury Department’s surprising turnaround on the issue of buying stock in banks, which has now become its primary focus, has raised questions about whether the administration squandered valuable time in trying to sell Congress on a plan that officials had failed to think through in advance."

The NY Times posed some tough questions in an article over the weekend in - "A Power That Might Not Stay So Super".

"At the heart of the troubles, both short term and long term, is debt. Debt helped create the housing bubble and has now left almost one of every six homeowners with a mortgage larger than the value of their home. Debt built up, and then laid low, modern Wall Street, where firms borrowed $30 for every $1 they owned. And in the coming years, debt will constrain the United States government, as it copes with the combined deficits created by the Bush administration’s policies, the ever-more expensive financial rescue and the biggest item of all, Medicare for the baby boomers.

In essence, households, banks and the government have already spent some of their future earnings. The current crisis marks the point at which the bills begin to get paid. Whereas Britain lumbered under the weight of imperial overreach, as the historian Niall Ferguson has written, the United States will be shackled primarily by its financial overreach.

This is not the first time in recent history that the economic position of the United States has appeared precarious. At various points between the mid-1970s and early 1990s, Europe and Japan each looked like the next great power. Neither turned out to be.

Japan suffered through its own burst bubble and spent years denying the depth of its problems. Europe proved unable to create engines of growth that could match the software, biotechnology or entertainment industries in the United States.

Taken to its extreme, the American preference for a faster, riskier capitalism led directly to the current crisis. But that preference also helps explain why America is weathering the crisis at least as well as other countries."


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