If there is one theme emerging from last week’s astonishing events (and I do mean a-sto-ni-shing) is the American government’s shift from its pre-electoral “Yes We Can!” mode to a brand new motto: “Because We Can!”
You may think it’s innocuous, but the change has important and ugly implications that go way beyond the cacophony of the disyllable “Because”. Let me explain…
…Starting with Ben going bazooka last Wednesday. Why did he do that?
“Well, because I can!” That’s (my imaginary) Ben speaking, so let me rephrase: Because that’s what he can… as neither the Obama Administration nor Congress can get their act together to clean up the banks from their toxic assets and help jumpstart lending. And so we get the “second”-best: A lousy use of Fed resources and a dangerous one too.
Lousy because buying Treasuries does little to reduce the high liquidity premia that are embedded in the current credit spreads. Lousier because buying mortgage-backed securities to support a sector that is in need of further price correction is neither sustainable nor desirable.
Lousier still, because Treasuries, even long-term ones, are liquid enough to be seen as close substitutes to the Fed’s cash in a world (our world) where access to liquid securities is the predominant concern. Translation: To the extent that banks continue to assign a high value to liquidity, they will not employ their newly-acquired cash into more productive uses such as lending.
Lousy again because, alas, it may have limited impact on Treasury yields (notwithstanding the market’s knee-jerk reaction last week) in the presence of leaks of the type “Ben buys, China sells.”
“Nonsense,” Ben retorts, “If that were to be the case, I’ll just do more!”
Right. Which is why it’s also dangerous. The Fed’s balance sheet is about to expand to levels that are turning the “medium term” into an unpleasant place to be. A medium term of high inflation, unstable bond markets or both. Let alone the potential interference with Fed affairs by a Congress too scared to see mortgage rates rise fast or too unsympathetic to the need to raise public debt to cover the Fed’s capital losses as yields go up.
Anyway, as if that were not enough, one day later we got another gem… With the speed and maturity of a toddler starting to shriek for being refused her teddy bear, the House passed a resolution to tax (ruthlessly) the bonuses of employees at firms receiving TARP money.
Whatever its “ethical” merits, the measure is counterproductive at so many levels it’s just not funny. The arguments have already been made so I’m just repeating: Congress is the new wild card in the game and, as such, it’s undermining the government’s engagement with the private sector—including in its efforts to resurrect the financial sector. Rumors have it that the sparse investor demand for TALF money last week was partly the result of such an uncertainty.
Congress also risks prolonging or exacerbating the crisis by compelling banks to give their TARP money back too early. In a research piece which, I should say, can be seen as unreservedly self-serving, US economists at JP Morgan (a TARP recipient) tried to quantify this risk: Accordingly, the return of TARP funds by those banks that can afford to do so would reduce GDP by one percent and employment by about one million, as banks would need to de-leverage further and halt lending to preserve their capital.
Whatever one thinks of these estimates (including their assumption that there actually exist TARP recipients who can afford to do away with any government backing, explicit or implicit), the fact of the matter is that banks will remain in zombie mode until the policy landscape clears. Which brings me back to our new motto.
Why would the House rush to pass such a myopic measure? Because that’s what they can! Frustrated, angry voters are calling for action… fast. Bankers are policymakers’ easiest targets. So let’s hammer them—now!—because we can.
Whether it’s Ben’s super-bazooka, a half-baked “stimulus” package or the taxes on bonuses, political expediency is leading to policies that are not second-, nor third- but “worst-best” if such a term can ever exist (I mean, there is also Zimbabwe).
In fact, reality seems all the more depressing when one contrasts the speed at which the House passed the resolution on bankers’ bonuses with the years of fruitless debates on much more worthwhile issues such as social security or healthcare reform.
So why doesn’t the government employ its tremendous political capital to move on with the historic problems that confront us and the ones that really matter?
Because that’s all they can.
Originally published at the Models & Agents blog and reproduced here with the author’s permission.