After a few weeks of relative calm – the economy was doing badly, but we knew that already, and there were no major controversies or scandals since the auto bailout and Bernie Madoff – the pace has picked up again. To summarize, in case you were on vacation this week:
- Bank of America started falling into the abyss, but got a lifeline, just like Citigroup 2.
- Speaking of which, Citigroup announced that its strategy for the last ten years has been a failure and that it is splitting itself into two banks, a “good bank” and a “bad bank” – but unfortunately it still owns both of them. It also announced $6.0 billion in increased loan loss reserves, $7.8 billion in writedowns on securities, and a $5.3 billion writedown on derivatives (I wonder how much of that affects the $300 billion in assets guaranteed by the government), but nevertheless made an Orwellian assertion of “Continued Capital and Structural Liquidity Strength.”
- The Bank of America bailout undoubtedly made Congressmen even more mad about TARP, but at the same time all these shaky banks (and personal lobbying by Barack Obama) convinced the Senate to release the second $350 billion (both houses would have had to block it). The vote was 52-42, with 46 Democrats and 6 Republicans voting in favor. From one perspective this is not surprising: the Democrats are supposedly the party of activist government, and it was mainly Democrats who passed the bill in the first place. But seen from a long-term perspective . . . the Democrats are the party in favor of saving big banks? and the Republicans are willing to let them fail? How things have changed.
- In a story that hasn’t gotten the attention it deserves (no doubt due to general bailout fatigue), Treasury is lending $5 billion in TARP money to Chrysler Financial. Now, is Chrysler Financial a healthy financial institution that just needs a little more capital to resume lending, or is it a systemically significant financial institution whose failure must be prevented? Right, I don’t know the answer either. But I guess after the GMAC bailout it was a foregone conclusion. Chrysler, of course, announced that it was relaxing credit standards and offering zero-percent financing on pickup trucks and minivans. (Full disclosure: I own a minivan.)
- The CPI declined 0.7% in December (excluding food and energy, unchanged), meaning that in Q4 the CPI fell by about 3.4% (excluding food and energy, it fell 0.1%)., further stoking deflation fears. But again, most of the fall in prices is just the reversal of the run-up in energy prices in 2007-08. Now that oil prices seem to have flattened out (gasoline and heating oil are up slightly), we should be able to see what is going on. I am still in the camp that the Fed will be able to prevent deflation. It’s basically a question of how hard they want to try, and they are afraid if they try to hard they will overshoot and create too much inflation.
- And Ben Bernanke gave a speech in which he floated the idea of creating a government-sponsored “bad bank” that would buy troubled assets from troubled banks: “Yet another approach would be to set up and capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank.” This idea got further support from Henry Paulson and Sheila Bair, and could be the big story of the next week (except for something else happening in Washington on Tuesday). Isn’t this original TARP all over again? Yes, it’s similar, but there are good ways and bad ways to do it. The biggest problem I had with original TARP was that it necessarily involved overpaying for assets; Simon and Peter have outlined one way of avoiding that problem.
Overall, this pace of news, primarily from the financial sector, has not been a good sign over the past several months. It’s usually a sign that things are going to get worse, although there is always some chance that this time we will solve these problems once and for all. And there is a new crew moving into town on Tuesday.
Originally published at the Baseline Scenario and reproduced here with the author’s permission.