Zombie everything

I think this post from the boys at The Economist goes in the right direction.  They correctly point out that it might be difficult to fix the economy if you are not even sure what the problem is.  For example ...

Maybe it's the Zombie banks:

In one corner, we have Paul Krugman and Adam Posen. Mr Krugman cites Mr Posen in a blog post today, saying:

The guarantees that the US government has already extended to the banks in the last year, and the insufficient (though large) capital injections without government control or adequate conditionality also already given under TARP, closely mimic those given by the Japanese government in the mid-1990s to keep their major banks open without having to recognize specific failures and losses. The result then, and the emerging result now, is that the banks' top management simply burns through that cash, socializing the losses for the taxpayer, grabbing any rare gains for management payouts or shareholder dividends, and ending up still undercapitalized. Pretending that distressed assets are worth more than they actually are today for regulatory purposes persuades no one besides the regulators, and just gives the banks more taxpayer money to spend down, and more time to impose a credit crunch.

These, in Mr Krugman's words, are, "[Z]ombie banks, unable to supply the credit the economy needs". The problem is that the economy will stagnate without a functioning banking system. Government transfers to the financial system, to date, are far too small to make the banks whole, and transfers of sufficient size would represent an enormous giveaway to shareholders. The solution, in this case, is nationalisation.

But the again, maybe it's the Zombie borrowers:

In a second corner we have Richard Caballero, Anil Kashyap, and Takeo Hoshi, who argue that the big problem with Japanese banks was not that they could not provide adequate credit to the economy, but that they continued to supply credit to the economy when they shouldn't have. In a paper titled, "Zombie lending and depressed restructuring in Japan", they write:

This paper explores the role that misdirected bank lending played in prolonging the Japanese macroeconomic stagnation that began in the early 1990s. The investigation focuses on the widespread practice of Japanese banks of continuing to lend to otherwise insolvent firms. We document the prevalence of this forbearance lending and show its distorting effects on healthy firms that were competing with the impaired firms...

Aside from a couple of crisis periods when regulators were forced to recognize a few insolvencies and temporarily nationalize the offending banks, the banks were surprisingly unconstrained by the regulators.

The problem is that zombie banks kept credit flowing to "zombie borrowers". Without good investment opportunities available (given economic conditions) these loans merely propped up failing firms.

Or, finally, it might be the Zombie consumers:

And in a third corner, we have Martin Wolf and Richard Koo. They argue that the root of the Japanese lost decade wasn't the banks at all—it was household debt. Mr Wolf writes:

Most of the decline in Japanese private spending and borrowing in the 1990s was, argues Mr Koo, due not to the state of the banks, but to that of their borrowers. This was a situation in which, in the words of John Maynard Keynes, low interest rates – and Japan's were, for years, as low as could be – were "pushing on a string". Debtors kept paying down their loans.

The problem is that households will neuter monetary policy by working to pay down their unmanageable debts. Banks are not an issue at all, so long as they aren't threatening the financial system by failing. The solution here is too prevent systemic collapse as cheaply as possible. In all likelihood, this involves propping up bad banks until they can earn their way out of insolvency, and engaging in large scale fiscal policy to avoid a debt-deflation spiral.

Fortunately, in the current situation, this turns out to be a remarkably easy question to answer; we've got Zombie everything.  Banks that don't want to lend, private equity companies that borrowed a lot and are now the only ones with an appetite for more borrowing (which unfortunately just goes to prop them up), and consumers that just want to pay off their debt. 

Zombies of the world unite!  You have nothing to lose but your brains!

They send us a toe ...

... we're supposed to shit ourselves with fear? This is not a stress test. These guys couldn't find reverse on a soviet tank.

Yesterday, as part of the stress test program, I've heard that the Fed issued two highly classified, double top secret documents for examiners and banks titled: "Template for Supervisory Capital Assessment" and "Supervisory Capital Assessment Program, Frequently Asked Questions: Participating Financial Institutions". These guidelines apparently specify how stress tests should be conducted and how to estimate loss rates under both scenarios (baseline and more severe).

What if I told you - not that I would know what is in these documents because my Q and TS clearances have expired - that these document suggests that under the more adverse scenario examiners should use a cumulative loss rate over the next two years below 30% for subprime first lien mortgages? Compare that to the Moody's updated estimate of 28% to 32% for their current baseline case.

Check out the charts in the first link as well. Then hunker down in your bunker and cover yourself in leaves -- it's going to be a long, cold lost decade.

Now we have a game show about a casino ...

"When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." -- John Maynard Keynes

At least we have had some progress since the last Great Depression:

Couldn't have said it better myself

Calculated Risk reads my mind.

From Bloomberg: U.S. Will Take Bank 'Ownership' Stakes Only as Losses Climb (ht Anthony)

Federal Reserve Chairman Ben S. Bernanke said the ... Treasury will buy convertible preferred stock as needed in the 19 largest U.S. banks after stress tests to determine how much capital is needed to address losses in a "worse" case scenario, Bernanke told lawmakers at a Senate Banking Committee hearing today. The shares will be converted to common only as the extraordinary losses happen, he said.

"It doesn't have an ownership implication until such time as those losses which are forecast in the bad scenario actually occur," the Fed chief said. Bernanke also said that the so- called stress tests that regulators will run on the 19 banks will look at potential losses over a two-year horizon if the economy worsens.

If the banks are seriously insolvent, this sounds like the zombie bank approach and rewards existing shareholders at the expense of taxpayers. If the banks are not seriously insolvent, this is a reasonable approach. But how does Bernanke know the solution before the data is available from the stress tests?

Would you be very convinced by a doctor who said, "Sir, we would like to test you to prove that you don't have cancer"?

Halleleujiah

Somebody had to say it:

I note with consternation Europeans’ obsession with regulating hedge funds and tax havens. Did they cause this crisis? No. Europeans also call for regulation of all markets, products and participants, without exception. This is like calling for research into radar while the Titanic sinks. Do they realise that the systemically significant banks at the heart of this crisis are the most regulated institutions we possess? Let us not be diverted from today’s priorities.

Our problem was emphatically not too much regulation, but bad regulation. We may have seen some hedge funds blow up last year, and we may see much of private equity disintegrate in 2009, but we should try to remember that while those guys may not have been regulated, the folks that stuffed them full of leverage were.

This is not my fault

Depression economics with a vengance