Saumitra Chaudhuri &=
nbsp; &nbs=
p; &=
nbsp;
Economic Advisor
=
ICRA Limited
26 K G Marg, New Delhi 110 001
Detritus of the Financial Disaster
Falls Upon Us
If things start falling on you, does it mean that =
that
stuff is dropping faster than you are? Or that may be you have hit bottom a=
nd
that things that have a built-in time-delay are now floating down upon you?
That is what I tend to think. Even as champion doomsayer Nouriel Roubini ups
his estimate for US bank losses to $3.6 trillion. On 20 Jan 09, he told
Bloomberg, “it means the U.S. banking system is effectively insolvent
because it starts with a capital of $1.4 trillion”, adding for good
measure “the system is bankrupt …. In Europe, it’s the sa=
me
thing”. With markets tanking over the past couple of weeks, as the
troubles in the US, UK and European banking industry once again come to lig=
ht
as December 2008 quarter and annual results hit the news, one cannot but ad=
mire
Prof. Roubini’s timing.
The fact is that all those who have like madaris opened up shop to sell the=
ir
personalised version of doom, purgatory and the irredeemable nature of Man,=
or
at least of capitalism, have had great assistance: First class publicity,
choreography and dramatic support, courtesy of the US Treasury, particularly
from its former Secretary, Mr. H.M. “Hank” Paulson Jr. One trus=
ts
that this support will prove not to be a continuing one in 2009. It is a
tragedy how poorly the subprime mortgage crisis and its contagion effects w=
ere
handled, leave alone its unfortunate (and avoidable) genesis. Here we look =
at only
one issue, albeit a major one, =
namely
the Troubled Asset Relief Program
(TARP).
In late September 2008, this column had argued tha=
t it
was imperative to sequester the suspect assets, so that as in Gresham’=
;s
law the bad financial assets do not drive out the good. We had expected dif=
ficulties
with pricing, if the assets were to be purchased outright, but had felt that
people so-much more knowledgeable than us would have anticipated these and
worked out solutions. The faith was completely misplaced. After invoking the
ghosts of the Great Depression, TARP was pushed through on the second attem=
pt in
US Congress. Once it became law, it was used not to buy off so-called ̶=
0;toxic”
assets, but to inject capital (against partial ownership) in US banks. All =
of
the major banks participated willingly (or otherwise) so that no one of them
would feel “tainted” by having to seek government bailouts. Mos=
t of
$350 billion of the available TARP funds were used thus.
The “toxic assets” remained in the boo=
ks
of banks and other financial institutions and therefore continue to require
write-downs, that is fresh losses continue to be charged. There is no real
market for such assets. Just the occasional small transaction and movement =
in
special indices used to track/simulate the prices of such assets. But that
requires more mark-to-market losses. Is it a wonder that, banks have clung =
on
to the TARP money, to help absorb these losses, maintaining them as part of=
the
$600 billion of excess reserves held with the US Fed? The legitimate
justifications for TARP was that it was (a) necessary to prevent a systemic
collapse and (b) temporarily free banks from the burden of “toxicR=
21;
assets such that their dys-functionality would not result in a general dys-=
functionality
in the economy at large.
Item (a) was the direct outcome of an official and
disastrous decision (to let Lehman go bankrupt) and was to an extent addres=
sed by
the bailout, that was followed by more assistance to Citigroup and the tube=
-feeding
of Merrill into Bank of America. Item (b) was not addressed. The reason why
after getting TARP passed in a mad rush to ostensibly purchase and sequester
“toxic” assets, the US authorities then did something quite
different was that it seems they were unable to settle on a “price
discovery” mechanism. The same or very similar assets had different
marked down book values in different banks and they felt that the political
correctness of a “price discovery” mechanism for an item which =
was
being only traded, in small quantities at isolated fire-sales, was more
important than doing the right thing with $350 billion.
If the dogma of political correctness (which by the
way keeps Larry Summers on the bench, while Tim Geithner gets to explain wh=
y he
forgot to pay his taxes) continues unchallenged, the more government gets
involved in the banking industry – in the US and the UK – the
longer it will take for the cure to happen. However, now that there is a new
administration in the US, which is surely more interested in producing tang=
ible
improvement in economic conditions and which has much more head room for
manoeuvrability than its lame-duck predecessor had, it may be reasonable to
expect appropriate solutions for the problems of the US financial industry.=
Surely it will dawn on people, who find the Decemb=
er
2008 ending quarter losses in financial and most non-financial companies wo=
rse
than expectations, that it is something of a miracle that these entities ar=
e still
around in January 2009 to report any results at all. For a moment in late
October and November it sure did not look all that of a certain thing. Whic=
h is
why, I see the weakness in markets this month, as more of a reaction to eve=
nts
that have already transpired. Enter the Obama administration, which surely
knows that if their actions are not seen to produce some improvement well
before the year is out, they will lose the goodwill and broad-support that =
they
will need for their longer-term policy goals. They also have had a long tim=
e to
observe the mess, with the advantage of being on the sidelines and therefore
under no obligations to offer solutions, but with privileged access to
information nonetheless.
Now, you might wonder, if sequestering toxic asset=
s is
such an obvious thing, why has nobody done it? Well actually, the Swiss hav=
e.
The Swiss central bank (SNB) has set up a special purpose vehicle, funded p=
rimarily
(90%) by SNB to buy $60 billion of “toxic” assets from UBS in
stages which puts in the remaining 10%. Additionally SNB will invest in
convertible notes of UBS. Then SNB buys the UBS equity for a nominal amount
(reportedly $1) and the cash flow from the sequestered assets is expected to
pay-off SNB for its investment. Over the past fortnight, the markets also s=
eem
to recognise this, as they have hammered UBS (and Credit Suisse) less than =
they
have JP Morgan and Wells Fargo, leave alone hapless Bank of America and
distraught Citigroup and British banks.
The UK appears to be headed down the road to
nationalisation. Given the much smaller constituency for such an outcome in=
the
US and the general low public support for what has come to be called “=
;corporate
welfare”, it may not be out of place to be cautiously optimistic and
expect that the Obama administration will do the obvious and thus stem the
needless rot in its financial system.
[Total number of words excluding title: 1,157]
<= o:p>