This is getting to be an exceedingly difficult question to answer when applied to the banking system. One mind-boggling loss surpasses the next, it would seem. Still, the rosy view has more than a handful of adherents. These folk argue that the worst is past, that the financial firms are taking their lickings and putting their past errors behind them. In this they are being assisted mightily by huge foreign capital inflows, as well as by the FED placing hardpressed banks onto life support.
Well, this all sounds very promising, to be sure. We do have a couple of concerns, however.
The first relates to the infusion of foreign capital. Our question is just this: suppose this mighty infusion -- and it is a mighty infusion when judged in absolute terms -- does not do the trick? The difficulty, it seems to us, is that even the mighty infusions we have seen, and additional infusions which may be forthcoming, are, in a RELATIVE sense, grossly inadequate to compensate for the staggering losses the banks have suffered and reported, as well as those they HAVE NOT YET HAD TO REPORT. We doubt that the banks have marked their mortgage-backeds and other junk bonds and loans to market. Moreover, we expect "the market" to continue to decline. If we are correct in this assessment, then those foreign capital pools (as well as the smaller fry American capital infusers) will experience a real-time decline in the value and security of their investments. Falling value, and spreading doubt about the ability of the banks to meet their debt and preferred stock servicing obligations could FREEZE any additional foreign/domestic capital infusions. Where, in that disturbing instance, would the banking system find itself? Since the capital infusions to date constitute only a fraction of the reported and soon-to-be reported capital losses of the banking system, and since 2 million plus mortgage resets -- and the accompanying negative impact of same on house prices and consequently upon the market value of the mortgage-backeds, the CDOs, and the mortgage interest money stream which mortgagees pay to their mortgage-holders and which are ESSENTIAL to the solvency of the lenders and the investors in mortgage-backeds, we can but wonder where all this will lead?
Certainly, confidence is a critical element of the equation, but it is only one element. More-- much more -- is needed than belief/hope that the worst is past, that the banks are on the mend, that we have seen the lows in the mortgage-backed and CDO markets, that there are some real good buys out there. We have heard too much of this stuff over the past 6 months: those who bought into these fairy tales have lost STAGGERING SUMS. Lenders to banks, and the mortgage-backed and junk bond/loan markets NEED to have some solid basis for optimism. The question is: are they likely to develop same? Every buyer/lender to the banks has thus far come to realize that his/her buys were TOO SOON. They have learned this by consulting their monthly statements, or by watching the powerful, near-daily decline in the price and salability of the "assets" they have purchased and the investments they have made.
Our view remains unchanged from the assessment we expressed in our earliest writings on this blog last August, when the blog began and the sup-prime crisis emerged. (The sheerest of coincidences, let us hasten to assure you). We said then, we have said repeatedly, and we say now: the crisis is too big to be contained, and then rolled back, WITHOUT SIGNIFICANT HELP FROM UNCLE SAM. There have, of course, been steps by the government and its instrumentalities (including a perpetually foot-dragging FED) to contain the sub-prime crisis, to prevent it from generating a true financial tsunami, which would eventuate in a severe recession or a depression a la Japan. (See our analysis: "Bailout by Bits and Pieces," and our analyses of the Japanese disease). The problem remains twofold:
--The FED remains contentedly behind the curve. In the face of a potential financial tsunami, this simply WILL NOT DO. We do detect the sharp rise in fear at the FED, which we predicted months ago. We do expect a more appropriate response from the FED, whose laggardness has intensified the credit crisis and prolonged significantly the forthcoming economic misery the country will have to endure. The intensification of "downside risk" in the economy they now duly note is primarily a consequence of THEIR HANDIWORK in implementing their grossly overoptimistic view by FAILING TO PRODUCE EVEN MNIMALLY ADEQUATE LIQUIDITY.
--The Administration remains mired in its laisser-faire ideology, though here too the press of reality (in the form of forthcoming elections) and lobbying from more sophisticated people (the Treasury Secretary, Dr. Feldstein, Mr. Volcker, and others) is having at least a verbal impact, to be followed, we hope, by some more meaningful action.
Our bottom line remains unchanged: the crisis is extremely serious, the response has been lamentable, but UNCLE WILL COME TO THE RESCUE. This is NOT the 1930s; for this generation, suffice it to say that the acute and largely unnecessary suffering of our forebears has had the happy consequence of precluding a non-response to a severe financial crisis.
