Monday, October 13, 2008

Inflation -- Bring it On

Well, that should fix it.

This evening, the Treasury department announced plans to spend about $113 billion of the bailout buying stakes in private banks. The banks are: Citigroup, Wells Fargo, JPMorgan Chase, Goldman Sachs, Morgan Stanley, State Street, Merrill Lynch and Bank of New York Mellon. Apparently, none of these banks were given a choice either.

This, at least, is a better way to bailout banks than buying their junk that nobody else wants. Still, the partial nationalization of the nation's biggest banks is a helluva drastic move in the direction of socialism. By itself, this is just bad -- preventing the liquidation of poorly run businesses so those that weren't poorly run can take their place.

That's just the creeping socialism part of the plan. The part that really stinks is the FDIC's new insurance program.

The FDIC will insure new "senior preferred debt" loaned by one bank to another for a period of three years. The intent and desperate hope is that with this guarantee, banks will start lending to each other again. Bank-to-bank lending had dropped drastically in the past month or so due to solvency fears.

Up to this point, the Fed and Treasury have been treating the current mess as a liquidity problem (i.e., assuming that the problem was that businesses didn't have access to cash or credit). Their actions had been for nought though, because the reason for the liquidity pressure was solvency fears. Banks knew that their own books were full of toxic crap assets, and that any financial institution wanting a loan was likely to be in the same state. Given the massive leverage in use, the odds were too good that the counterparty could go under way too quickly as the leverage unwound (like Bear Sterns, Morgan Stanley, Merrill Lynch, Wachovia, Washington Mutual, AIG -- these aren't unfounded fears).

So now, the FDIC is the guarantor of solvency for at least some lending. The part of me that's cognizant of our nation's $10+ trillion debt, $600 billion deficit for next year (that's before the cost of the current fiasco and it's attendant tax receipt reduction -- new estimates are $2 trillion deficit), and $53 trillion in unfunded liabilities makes me wonder just how solvent the FDIC really is. They've got a bit of money on hand -- somewhere in the neighborhood of $40-50 billion.

$50 billion sounds like a lot, until we remember that we got into this mess because bad loans caused more than $635 billion in writedowns across the financial industry. With a whole passel of Alt-A mortgages resetting in late 2009 through 2012, more pain is coming. Oh, and credit card defaults are up, and Home Equity Line of Credit payments are getting late, commercial real estate is trending down, unemployment is on the rise, and consumer spending is (finally!) slacking off.

It is worth asking why our current financial crisis is a solvency crisis.

Fortunately, the answer is pretty easy to determine: way too much credit was extended and debt became too cheap. When the hangover finally hit, what have the Fed and the Treasury done -- switch from Mad Dog to Jack Daniels.

They've brought out the good stuff, and things will probably be pretty sweet for a little while. I've just got this terrible feeling we're gonna wake up in a dumpster hung over as hell and cuddling a three-day-dead dog.

Inflation can be like that.


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