There Won’t Be An Economy To Stimulate Without Solvent Banks

Uncertainty, Volatility, And Inaction Since this crisis began, we’ve seen uncertainty, volatility, and inaction play out not only in the financial markets, but also in the halls and minds of our elected officials. Each is a bane to the economy, and stifles the ability of market participants and consumers to plan and carry out the business activities that keep people employed and spending money. A new chapter in our venture into the unknown began when Timothy Geithner announced his six and a half page plan to save the Universe. Although the DJIA is often and unjustifiably described as the “market” and any movements therein deemed the “market’s response,” it was clear by the end of that Tuesday that at a minimum, the equity markets did not like Geithner’s plan. But more importantly, in my opinion, is the reemergence of a disturbing upward trend in certain indicators, such as the Swap Spread. This suggests that banks are, once again, becoming more reluctant to lend to each other. To put things in less technical terms, the inter-bank lending markets are providing the steady drum beat of our death march, while the equity markets contribute unwieldy gesticulations of terror.  The result is hardly efficient, and something drastic must be done if the banking system and the broader financial markets are to recover.

Defibrillator For A Corpse Regardless of your position on government spending and its effects on the economy, without solvent and functioning banks, there will be no economy to stimulate. If we continue to ignore the fundamental role that banks play in our economy, debates on government spending versus lower taxes will be had over burning garbage bins and cans of beans.

Our economy requires functioning credit markets in order to operate. Credit markets have grown to become dependent on the broader financial system because of the way in which credit risk is traded and distributed. Therefore, without functioning, solvent banks to create and manage these markets, and without investors confident in the stability of the broader financial system, our economy cannot function, no matter how much money we throw at it.

Despite this, the current administration has thrown all of its weight behind a gargantuan spending bill without first solving the core issue that precipitated and underlies the crisis: bank insolvency and illiquidity. This influx of cash may stem the tide by keeping certain businesses and consumers afloat with government cash, but it does little to nothing in the way of restoring stability and confidence in the financial system. In short, no matter what your economic philosophy is, pragmatism dictates taking action to restore the viability of the banks.

Originally published at Derivative Dribble and reproduced here with the author’s permission.

One Response to "There Won’t Be An Economy To Stimulate Without Solvent Banks"

  1. Guest   March 6, 2009 at 12:31 pm

    The key point is investor and consumer confidence in the whole financial system. Just making (new, honest)banks solvent will be insufficient. Confidence will need to be resurrected in the Treasury, the Fed, the political leadership, and the fiat money system (the Full Faith and Credit of the United States). Good luck. Maybe they are the problem and not the solution.