The Fed is now struggling with how to make sure that banks don't just hoard the money they've been handed by the government.
The banks have been bailed out, now let's see the cash
The markets continue to bear the blows of de-leveraging. Hedge funds are undoubtedly collapsing and with them their equity positions. Undoubtedly this will turn up bargains at some point. Just perhaps not today. The problem is that while many stocks look cheap compared to their companies' earnings, project earnings are these days somewhat unreliable. No one knows just how bad the recession will get. Bush seems insistent that he be seen as doing something, anything, and so has called a lame duck talkathon of global leaders to make sure markets don't think the ship is completely rudderless until January.
The Fed is now struggling with how to make sure that banks don't just hoard the money they've been handed by the government. One problem with the structure of the bailout so far is that, in their concern about the moral hazard of bailing out greedy bankers, the government has demanded that banks pay it interest on their preferred shares. Actually, this should be the other way around. The banks now have a cash flow risk: how to ensure that they can pay the government's interest on time. Lending is risky, so best to keep the capital in cash.
Again we can turn to the IMF solution in Indonesia for answers. There, the government took stakes in weak banks, with no preferred share structure to protect existing shareholders - who were most often genuine crooks. Instead of collecting interest from the banks, the government recapitalised them by selling them recapitalisation bonds, which would sit on the asset side of the banks' balance sheets and pay them a regular sum of interest, giving them cash flow and a profit.
So now the Fed and the Treasury need to devise a means to encourage banks to lend without raising the risk of failure and government conversion of preferred shares into common stock. Lending them discounted T-bonds might be some form of remedy. But in Indonesia, banks also hoarded their recap bonds, collecting the interest and banking the profits rather than risking their money as loans. It took years before the Indonesian economy improved to the point that they got back into banking.
Authorities in the UAE should be studying these moves to determine what to do with their own banks once the property market goes through what now appears an inevitable - and imminent - correction. Absentee landlords from abroad are likely to be hit hard by the global recession, and will probably not want to move into the one-room flats they've bought to rent out to foreign workers. Merging banks here makes some sense, so long as stronger banks take over weaker banks. Often in crises weaker banks like to merge with their peers, creating even larger banks that the government will have to bail out. Undoubtedly, the UAE banking sector is overpopulated. Consolidation may have to be stage-managed. Bankers here wonder where the Dh70 billion injection the Government pledged has gone. So far, only Dh25bn has been deposited at banks, with strings attached: it must be used for loans to the construction sector and trade. This makes sense, provided the construction sector does not include loans to developers for yet more developments. But if it keeps the cranes moving, so much the better. It still isn't clear to me, however, just where this Dh70bn is coming from. Since it was supposed to be from the Finance Ministry, it needs to be in the federal budget, which it couldn't have possibly been. So perhaps this will be included in the new, expanded 2009 budget, which is advertised to be 21 per cent larger than the 2008 budget. Meanwhile, the US government appears to be tackling the other problem I've raised: how to get the US consumer back on her feet. Americans don't have savings like the emerging world to fall back on. They used to have their home values. Now they don't have that. So the plan to unleash a $40bn homeowner rescue package is probably a good idea, provided it goes to the most creditworthy homeowners facing default and not the subprime borrowers who shouldn't have gotten home loans in the first place. For those who still think the taxpayer and the shareholder are different people, check out the red ink spilled over at the US Pension Benefit Guaranty Corporation, which guarantees US pensions. It just announced $2.1bn in losses, which is likely just the start of the agony that the baby boomers are about to live - and die - through. Goodbye Yellow Brick Road. Now the Michigan caucus is trying to get the Treasury to support American car loans, which in a country with little to no workable public transportation system, makes some sense. Pity for the environment. Good for oil, and for oil exporters like us. Go Michigan. As the global outlook grows bleaker, we need to be on the look-out for the rogue economy that becomes the catalyst for unrest. Russia, strangely, appears to be chastened by lower oil prices and is becoming more conciliatory. Will the same hold true for Iran? firstname.lastname@example.org