It has not been an easy first few weeks for Barack Obama, the US president, as his administration has had to struggle in the face of a soured atmosphere in Congress and markets demanding instant gratification to have the bank rescue and massive stimulus package passed quickly. Market needs and political needs are divergent things, and there is an acute disappointment risk relative to hopes that Mr Obama's team will have a silver bullet for the financial system's woes even after the grudging passing of the much-awaited plan.
Rather than having a single or swift answer, the administration's economic team is looking at its policy initiatives as three major, interrelated packages that are all likely to be completed this month. The stimulus bill will have an impact on the real economy, the bank rescue package will aim to unclog the financial plumbing and a housing package will target foreclosures and aim to prevent further deterioration in housing loans on bank balance sheets.
Each piece taken individually would be judged inadequate, and there is a mismatch between market expectations that a credible bank rescue plan must have a headline figure of near US$1 trillion (Dh3.67tn) and the political stomach for spending of that order. The final agreed package, worth $789 billion, includes tax cuts and spending aimed at rescuing the US economy. Administration sources want the impact of the three packages to be judged on how they operate as a whole, not as separate parts. The bill includes help for victims of the recession in the form of unemployment benefits, food stamps, health coverage and more, as well as billions for states that face the prospect of making deep cuts in their own public spending. It is one of the most expensive pieces of legislation ever to come before the US Congress and it has caused bitter partisan divisions.
The final compromise and trimmed-down bill may ominously indicate that Mr Obama, for all his communication skills, has lost the message war over a stimulus package being criticised for too much long-term wishful thinking and hope, and too little short-term stimulus, by stripping out spending on programmes that will have little impact this year and next year. It is the size of a downsized "aggregator bank" that is at the centre of market interest. The rescue plan will include purchases of toxic assets through a "bad bank" vehicle; government guaranteed insurance wraps to remove the tail risks of impaired assets on bank balance sheets; and further bank capital injections.
The guarantees will come at no upfront cost to the government, and will, in fact, generate revenue as banks taking up the guarantees will have to pay a fee. The potential costs at the back-end, though, could be substantially higher if the US economy continues to falter and, worst of all, the guarantees do not in themselves remove the legacy assets from the banks. The asset purchases would be aimed at legacy toxic assets of what were once tradable structured securities, but have been so difficult to price and trade. Assets, once purchased, would be farmed out to managers to either sell at a profit or to hold to maturity. The bet, or prayer, is that once purchases are under way, there will be a dynamic impact on the "good bank". Banks will be freed of the burden of setting aside capital for the toxic stuff, the mechanism will help determine market pricing for some assets, and this is all hoped to encourage investors to step in to recapitalise the banks on the expectation the banks will be back in the business of generating income producing assets.
In addition, the securitised mortgage market could begin to revive. But the heavy lifting in the package could fall on the guarantees, which would offer up layers of government insurance, after a first loss by the bank itself. Guarantees would be structured to kick in at levels below present bank marks, but would create a floor against extraordinary losses. The idea is to remove the tail risk on bank balance sheets, with guarantees aimed at "regular" lending and assets that were intended to be held to maturity but whose credit quality is deteriorating as the economy nosedives.
Market confidence is the key, not just in the US but around the world, as consumers no longer seem to believe in quick-fix miracle solutions. Politicians, though, seem eternally optimistic as Joe Biden, the US vice president, said the passage of the bill would be an important psychological moment for the country as it grappled with the economic downturn. "It is the thing that will kick-start the confidence, the psychology that we can climb out of this," he said. Let's hope the magic silver bullet works.
Dr Mohamed A Ramady, a former banker, is a visiting associate professor in the finance and economics department at King Fahd University of Petroleum and Minerals in Dhahran, Saudi Arabia.