Johnson and Kwak over at Baseline break it down. Their analysis: we have some serious problems.
Like the global economy, the U.S. economy only looks worse than it did two months ago, with unemployment up to 8.5% and no real indicators of an incipient recovery. (See Calculated Risk’s March summary for all the dismal details.) The causes of economic weakness are largely unchanged and widely known.
They go into a bit more detail about the stress tests and the PPIP scam – and they are not even worried about outright gaming of the system:
The stress tests have two main problems. First, they are no longer credible, because the worst-case scenarios announced for the stress tests are no worse than many economic forecasters expect in their baseline scenarios. Second, the administration has as much as said that the major banks will all pass the stress tests, making it appear that the results are foreordained. It is possible that the stress tests will be used to force banks to sell assets as part of the PPIP, which would be a good but unexpected consequence.
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As long as the government’s strategy is to prevent banks from failing at all costs, banks have an incentive to sit the PPIP out (or even participate as buyers) and wait for a more generous plan. Again, the key question is how the loss currently built into banks’ toxic assets will be distributed between bank sharedholders, bank creditors, and taxpayers. By leaving banks in their current form and relying on market-type incentives to encourage them to clean themselves up, the administration has given the banks an effective veto over financial sector policy.
The constraint that you will notice is the refusal to allow banks to fail. The banks know this. So we are well beyond your garden-variety moral hazard; the banks are playing with the house’s money, and have no desire to acknowledge any losses. They get the FASB rules changed when they don’t like the outcome. They get the government to buy in their mistakes. All because the government is fundamentally unable to face the prospect of a major bankruptcy.
I would urge a different path, not only because it is the right thing to do but because it is politically advantaged. Think of it as a variant of the old line that the first thing you do with a bully is punch him in the face: if the government blew up AIG or Citi or BofA, it would be showing that no one could hold it hostage. There would be some immediate panic, but the economy would quickly find itself on more stable footing. Contrast this with the government’s capitulation in October, which stemmed the tide for a month but otherwise left us with all the same problems.
UPDATE:
Similar post over at Mavercon:
the US Treasury is now following the UK and German example by trying to be a little bit pregnant: offer state money, make it painful and expensive for the incumbent management, board and other vested insider interests, but keep it voluntary. I am sure they are going to be lining up in droves to take advantage of this unique opportunity to do the right thing.
It isn’t hard. Take a leaf from Winnie the Pooh. Pooh was a bear of very little brain, but at least he had courage. Or from the Wizard of Oz, a literary reference perhaps closer to those in charge (but not in control) of US economic policy, take a leaf from the Scarecrow and the Cowardly Lion. With a little bit of brain power and a little bit of courage, this crisis can be overcome.
