I have read Krugman, Roubini, Becker, Setser, Cowen, Mankiw, Stiglitz, Bernanke, Volcker, a former BOJ governor from the 1990s (sorry will try to get name, many economic and policy bloggers (on the right and left), numerous economics reporters, most of those in Congress courageous enough to talk about the crisis, and many others. Many of these individuals write and speak directly about the financial system, but many others only speak about elements of the recession or financial system. Through these thinkers I have gained what I believe to be a pretty decent understanding or the problem and possible solutions. (Disclaimer: I did make some admittedly bad assessments of the Bad Bank)
At this point my belief in the correct solution reflects both the political possibility and the economic imperative. Now, I must confess I do not completely understand the Geithner plan, but there is a chance that it is really really good. When I first heard the Geithner speech and envisioned what it actually meant I was upbeat.
First, this crisis has been handled from the supply side the entire time, and that response has been slow, inefficient, and necessary. One, aspect of the plan that looks promising is that banks getting TARP money will have to use the Sheila Bair loan modification method. Reports are that she started using the method during the IndyMac receivership, and estimates are that 1/3 to 1/2 of loans can be modified leaving both the homeowner and investor better off. I have talked on this blog about the very externalities that follow the unnecessary foreclosures (all foreclosures really). Hopefully, the administrations housing legislation is fair but ambitious because the housing issue needs a demand side solution as well.
Second, is the effort to try to loosening consumer lending markets: student loans, auto loans, etc.
Third, is the Geithner "stress test" plan. This is the part of the plan that is a little squishy, but could be good. From my reading a few of the foremost experts on these type of crisis are a few names in Sweden and Japan, Brad Setser, Nouriel Roubini, and Tim Geithner. So, when I hear the folks in the media say no one has any idea how to handle this crisis, I shake my head. If the plan looks like what Calculated Risk wrote tonight, it will be good, but time will tell how good.
1.) The stress test will look at the banks solvency over the next two years, considering both the balance sheet and off balance sheet instruments. There are two essential elements here. First, that the test include off balance sheet instruments. Second, that Geithner and Co. err on the negative side, in other words view all potential losses as losses - even the pretty farfetched.
2.) Structure the test in a way that all information about the 18 big banks is released all at once.
3.) That the 5 to 8 banks that are insolvent go under recievership with the FDIC. Now, this is the most important step. This is a political tight rope walk, but if it is explained to the public in a way that people know the FDIC is doing what they do everyday it will be excepted. Each of these institutions will have their balance sheets cleaned up then will be sold off.
4.) The key to all of this is who and how many banks fall into the above category, and which and how many banks will be close to the line. Then, for these insitutions on the proverbial edge, how much money will they need? From everything I know about Tim Geithner and his experience, he will err on the side of insolvency and receivership. This is the big question though.
I have some Law and Economics tomorrow, but I will be back Friday to talk about the next step - Financial Regulation and Oversight to bring confidence back to the financial markets.
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