Martin Wolf on the Obama Financial Plan

Our text for today is the excellent, thoughtful, and illustrious Martin Wolf, who writes:>Martin Wolf – Why Obama’s new Tarp will fail to rescue the banks: The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this “progeny of the troubled asset relief programme” fails, Mr Obama’s credibility will be ruined…. All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency. Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses….>Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities….>Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst….>The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem….>Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress….>The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once…. By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.I am, once again, having a hard time wrapping my mind around the concepts of “illiquidity” and “insolvency” here. As Larry Summers once said: “if there is no doubt that an organization is solvent how can it ever be illiquid?” Somebody who has cash will be eager to lend it to the institution at a rate epsilon above the prevailing safe interest rate, and then it will no longer be illiquid

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s