TALF details suggest Obama doesn’t get it
Marshall Auerback here. As Ed lucidly suggested to me by e-mail:
“We see the Fed giving a loan for assets at the price as reported on the institutions’ books. Otherwise, you have to take a write-down just to get the loan. That’s a non-starter. So the Fed is going to take the asset as collateral at its reported value and will administer a haircut of 5-16%. This program is applicable only to certain AAA paper to diminish the possibility that more haircut would be needed (I am sceptical here).
If irrational despondency goes away, the loan is repaid. However, if the asset falls in value, the Fed has no-recourse. Given the fact that they have already mentioned the SPV, it suggests the investment company could then renege and have the collateral seized with no other penalty.”
But a lot of this is not “irrational despondency”. The reality is that large chunks of these toxic “assets” are not “impaired,” or “illiquid,” or “distressed”. They are worthless, now and forever – unless the peak real estate values of the bubble can miraculously be restored and a whole bunch of deceased LBOs can be raised from the tomb. The banks know this, investors know this, Geithner and Co. know this. And everybody knows that the others know. This explains why no bank can secure any interbank funding of size for periods beyond a week. Geithner and Lawrence Summers have concluded the only way to get private investors (many of whom have already lost a few pounds of their own flesh to the bear) to bid on these assets is to make them offers which effectively guarantees them a profit.
So I’m guessing it’s buying the assets on the banks’ books for a small haircut and then eventually having them dumped back on the Fed.
Or they are wagering on creating sufficient inflation that the toxic dump is magically made whole. Call in the “Zimbabwe lite” option – sort of like raising the dollar price of gold to increase the net worth of banks, governments, holding gold. But, I don’t see the latter as a realistic possibility the way things stand right now. Core CPI inflation is now at a 0.9% annual rate over the last three months. As recently as the first half of last year it was 2.3%. Maybe the last three months represents the underlying recent past inflation rate. Maybe the fall from a 2.3% rate to a 0.9% rate is the true pace of decline in core inflation. That’s more than 2 percentage points in half a year. Another 2 percentage points by late this year would take us into outright deflation comparable to that of Japan.
These same economists refuse to predict outright price deflation even though they predict a rise in unemployment to perhaps 5 percentage points over the NAIRU. That constitutes very considerable acceleration in labor market slack since the period prior to September of last year. All Phillips Curve logic says such accelerating labor slack should take the already marginal positive core inflation rate into negative territory. The vast majority of economists refuse to acknowledge such simple economic logic.
I have been looking at economic data for the U.S. and many global economies for decades. I am now seeing something I have almost never seen: announcements by companies of outright cuts in base wages. To this we must add the obvious huge cuts in variable compensation which has become so large a part of total U.S. compensation.
In the end core inflation is compensation inflation minus annual productivity gains. Huge labor slack should take compensation inflation to zero or worse. The anecdotal evidence of a decline in compensation inflation, especially as regards the “variable” component, is everywhere. Productivity gains should take the economy into core deflation. With so much corporate cost cutting positive productivity gains are not going to go away. It seems to me the case for deflation is becoming more compelling.
In a recent analysis by Jan Hatzius in Goldman Sachs When ZIRP Is Not Enough Help Wanted! A Spender of Last Resort, January 23, 2009, Hatzius applies the Taylor Rule to a US economy with a zero federal funds rate, marginally positive (one quarter of a percent) inflation, and an unemployment rate that rises to 9.5% by the end of 2010. He concludes that, according to the Taylor Rule, under such conditions the zero federal funds rate will be a full six percentage points above the appropriate policy rate by the end of 2010. There is another way of looking at this. If the US economy goes into deflation, real interest rates will rise. With a huge excess of private debt and a raging financial crisis, rising real interest rates will be a significant depressant on an already falling economy.
And we’re clearly not doing enough to stop this. I am stunned at the number of people who think Obama has had a great start. This complacency will ensure that the policy response invariably remains well below what is necessary and we’ll get the invariable backlash from the right, as Megan McArdle’s comment suggests:
“There is a very real possibility that in two or three years, America will be in worse shape than it is now-unemployment in the double digits, GDP down by same, corporate and government budgets peeling apart at the seams. I will be curious to see whether the new armchair empiricists of the left see this as casting any doubt on their central theories, or whether they will simply argue the counterfactual.”
I really don’t think Obama “gets it”, despite what he said in his speech. Rome’s burning and Geithner and Summers are fiddling away taxpayers dollars on a futile attempt to prop up destroyed banking edifices.
UPDATE: I think reader Brian’s points on the TALF are well taken and I may have to revise my view on TALF somewhat. I still think this is an attempt to restore the shadow banking system via other means and that this is wrong, but it appears to me that what the Fed is seeking to do with TALF is BYPASS a diseased banking system and establish new credit channels for consumer loans, auto loans, other asset backed securities etc., which have been shut down by the credit crunch. As Brian said, key is that the TALF will only be used for asset backed securities issued after Jan. 2009, so that you do avoid a lot of the toxic crap. True, the taxpayer might still take a haircut ultimately, but the risks of that are considerably lower with stuff issued now than stuff issued in 2007.
The only flaw is not with TALF per se but the fact that neither the Fed nor the Treasury are grasping the nettle in the banking system by dealing with the pre-existing buildup of toxic assets still on the balance sheets of the money center banks, but simply trying to bypass it altogether. So in its attempt to establish fresh credit flows, the Fed risks establishing another parallel banking system. Is this really what we want?
The power of government – Megan McArdle