Friday, October 03, 2008

Some Gloom and Doom

Last night PBS NewsHour treated us to a roundtable discussion featuring Ken Rogoff and John Cochrane. Rogoff is a Harvard professor and former chief economist for the IMF and a guy who I read every article that he writes. We had to write a paper based on some of his research in grad school. I've always found him to be smart, ahead of the game, and on the mark.
Cochrane is an economics & finance professor at the University of Chicago who helped organize the petition against Paulson's original bailout plan. He wrote a detailed post for Freakonomics this week. They are joined by another finance wonk on the show.

You can read the transcript and/or watch the video here. Highlights:

I think the modified bill is, in fact, worse than the original bill. Many of the modifications are either counterproductive, hugely expensive, or a pinata full of ridiculousness.

Rogoff thinks the best idea so far is raising the deposit insurance protection to $250,000. But he adds:

I certainly don't think this is the end. This is a step. It is not going to work. It is not going to be enough.

Eventually, we have to do something like Professor Cochrane suggests of injecting capital into the banks in return for senior equity, putting the taxpayer first.

We've got to close a lot of the banking system. The banking system is still bloated. They have to get auditors in there to choose which banks close. It's going to take much firmer intervention.

There are other plans. There are some involving helping the homeowners directly.

This is not the last word. The final cost is actually going to be much greater than what's projected from this bill, but we're in paralysis here.

The spreads are exploding. Companies are having trouble meeting their payrolls, if we don't get the credit markets moving. You can't just, you know, talk about theoretically what's the best thing to do. You have to stop the bleeding.

He believes that the current bailout bill won't cost us more than $700 billion, we'll probably make profit off of it as the acquired assets gain value and Treasury eventually sells its equity stakes. However, it doesn't do enough because we need to see a lot more banks fail. Instead, some of these failing banks will be given money from Treasury for their toxic assets just before they go out of business, and in that sense there's going to be a lot of waste.

This seems to be the view among leading economists: The worst is yet to come and something else will be needed next year under a new President. The current Fed and Treasury interventions are going to lead to greater inflation and more hardship.

Nouriel Roubini, an economist who was prescient in seeing this whole mess coming years ago, writes for Forbes magazine:

The next step of this panic could be the mother of all bank runs, i.e. a run on the trillion dollar-plus of the cross-border short-term interbank liabilities of the U.S. banking and financial system, as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. A silent cross-border bank run has already started, as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure. And if this run accelerates--as it may now--a total meltdown of the U.S. financial system could occur.

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