- To reduce the counterparty risk in the money markets a triage between insolvent banks that need to be shut down and a recapitalization of solvent banks is necessary together with massive injections of liquidity in non-banks and the corporate sector. Yesterday’s plan to support the commercial paper market – something I recommended last week - is a step in the right direction. Direct lending by the government to small businesses – via the Small Business Administration – is also necessary to avoid the implosion of smaller businesses.
Bypass banks and give straight to small business. Hmm, where have I heard that before? I think some Democrat might have an idea. More broadly, he wants government to step in and reduce uncertainty about risk - this bank's a goner, this one will make it, here's the money you need to tide you over until Bank B is stable. In order to do that, a second action must be taken, one that the FDIC is itching to do:
- a generalized temporary blanket guarantee of all deposits is now necessary both in the US and in Europe followed by a triage between insolvent banks to be closed rapidly and illiquid but solvent banks that deserve to be rescued to avoid the moral hazard of such blanket guarantee;
This is to prevent bank runs so that we can see who is and is not solvent, and to ensure that regular depositors do not get cleaned out by larger institutional players. These two measures make a pair. You can't really have one without the other. Third, in addition to guaranteeing deposits and injecting money directly into commercial operations, the toxic assets themselves must be dealt with. Of course, this being Roubini, there are a lot of clauses:
- the flawed $700 bn TARP legislation will have to be modified in three ways to: a) allow for direct government injection of public capital in banks in the form of preferred shared matched by private capital contributions by current shareholders (via suspension of all dividend payments and matching Tier 1 capital provided by private shareholders); b) implement a clear plan to reduce the face value of mortgages for distressed home owners and avoid a tsunami of foreclosures; c) do a rapid and radical triage between solvent banks and insolvent banks that need to be rapidly closed.
Inject capital and get shares in return. This gets a firm grip on the companies making the deals. It makes the people with the money cough up their profits and their privileges. Make them take the downside of investing and not just the upside of infesting. The big deconstruction of the shitpile that is going to have to happen is to revalue the underlying collateral, i.e., cut down the housing value. This needs to be done for any home purchased or refinanced between 2003 and the end of 2007, even if the mortgage is not in trouble. That is the only way to be fair. I think the third is simply moving assets from insolvent to solvent banks, but I can't be certain. I thought he already addressed in in point #1, but maybe I'm missing something. Anyway, these are proposals at least one leading Democrat has been discussing for a few months now.
Finally, Roubini goes right at The Village with this challenge to the Conventional Wisdom that we must tighten purse strings:
- given the collapse of private aggregate demand (consumption is falling, residential investment is falling, non-residential investment in structures is falling, capex spending by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate) you need to give a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than spending and investing it is necessary now to boost directly public consumption of goods and services via a massive spending program (a $300 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be sharply increased together with a targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and growing budget deficits; but $300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets.
Shorter Roubini: Put money into the hands of people who will spend it so we can get credit and capital in motion. This is much like what James Galbraith proposed several weeks ago as we first saw the wave crashing down. I wonder who is out there proposing we spend on infrastructure and human capital, and not even bothering to hedge the bets with platitudes to win approval from the High Broderists?
The system needs both liquidity and capital in amounts and in vehicles that can be measured, tracked and trusted.