That Was Close

We have a package, the heart of which remains Bush’s original idea. In the absence of an agreement, tomorrow’s equity markets would have melted, Tbill rates hitting 0.0%. That’s for starters. Next would have been the beginning of a bank run (we’ve already seen isolated instances). Financial institutions would fail at an accelerating pace, savings would have been wiped out, jobs evaporate, the economy tank. This would cost us a hell of a lot more than $700bln.

For pure libertarian types - how long can you hold your breath? Until the market regains its sanity? What’s the sense of being right if the markets don’t agree and convert you to crow bait in the process? We can argue about "obscene pay packages," golden parachutes, the notion of socializing losses while privatizing gains, all of it. We agree but save that for later. This is not GM or Wall Mart; this is the financial web and by its very nature it is a house of cards.

Recall from Econ 1-A that roughly 80% of bank deposits are backed not by cash on hand, but faith. No bank could cover all its deposits given a panic by savers, not close. Recall that banks borrow (from us) short term and lend long term, making a profit on the spread. That’s why they can’t honor all their deposits at once - no way to quickly liquidate this stuff. But given a panic, the banks begins to sell - fire sale. Vultures sense the opportunity. Those assets, bank assets drop in value in a hurry and most banks hold the same kind of assets. The draconian accounting practice of "mark-to-market" forces all banks to mark down theirs too - right now, and take the losses.

Such a run was until this morning just around the next corner. People are darn nervous, despite the commendable handling of Wash Mutual by the FDIC. (There was only a small "run" of depositors withdrawing their money from WaMu branches earlier in the week. The FDIC moved in Thursday night, rather than waiting until Friday night as it usually does. It probably feared that the depositor run would get worse on Friday, and it didn't want images of depositor lines outside WaMu branches in newspapers, newscasts and Web sites over the weekend.)

The administration’s plan may be flawed; there are plenty of others being bandied about including going to 0 on capital gains, repeal Sarbanes-Oxley, suspend mark-to-market rules for 6 months, extend the Bush tax cuts, the compulsory conversion of some of the banks’ debt into equity and so on. Flawed or not, the present package as we understand it will be enough to stave off what otherwise would have been a catastrophe. Fine tune later. Fortunately we may not have to stomach Dodd and Frank’s proposal to put 20% of any profits from re-sale into an "affordable housing" fund for their pals, instead of retiring our, US taxpayer, debt. Apparently that has been dropped.

Finally, for those who still advise nothing, from today’s WSJ: "Anyone who thinks capitalism will fare better after a crash should recall that the 1930's didn’t end politically until 1980."

Robert Craven