x Abu Dhabi, UAEFriday 19 January 2018

The banks of America

The US bailout is expanding as the economy worsens. Now the Fed is buying more long-term debt with newly minted money and the Treasury Dept is going to bail out life insurers with TARP funds.

The US bailout is expanding as the economy worsens. Now the Fed is buying more long-term debt with newly minted money and the Treasury Dept is going to bail out life insurers with TARP funds. This will leave less to bail out banks as it becomes necessary thanks to stress testing and PPIP. So we have another long, drawn-out, battle in Congress to look forward to when the Obama administration goes back for several hundred billion more dollars. With this in mind, the Obama administration is now trying to convince private investment firms - the ones it will be co-investing remaining TARP funds with for the PPIP - to market their investments in toxic assets to the general investing public.

To some this is an affront, asking John Q Public to front more cash on top of his taxes. And that would make sense of taxpayers could reasonably expect refunds if the governments investments succeed in either resuscitating banks or even producing profits. But everyone knows that's not how tax collectors work. Thus, this is a smart move, one that, if it can manage to win over a sceptical public that has already been trained by an uninformed media to vilify bankers and their complex mortgage-backed assets. By giving the small investor a more direct potential upside form the bailout, it will give Main Street a bigger and more direct stake in the resuscitation of Wall Street. As if the two were ever really as distinct as has been made out.

Predictably, most all of the 19 banks being submitted to Geithner's "stress tests" are apparently coming out with a passing grade. Critics have said the tests are rigged that way. Remember, these tests are designed to determine which banks are too sick to rescue if the recession gets worse and which are healthy enough to warrant more federal plasma to keep on life support. This means more bailout funds for all 19, since the worsening economy is almost certainly going to put more of their assets under water, forcing more write downs and bigger hits to the banks' capital adequacy. And if PPIP works as intended, it will force banks to take even more write downs on money-losing securities they hold.

A Congressional panel is raking Treasury over the coals for not firing all the bank's management, forgetting it seems that except for Bank of America, all the banks' managements are new, dating from after the crisis first erupted in the fall of 2007. Besides, some economists say banks are something of a red herring in all of this. Only 27 have failed, compared with thousands in the S&L crisis (the banks now are much bigger, of course). And if the Depression taught the US anything, it was how to handle a failed bank. The bigger problem, they say are investment banks and insurers. We saw what can happen when an investment bank goes bankrupt when Lehman Brothers failed. Global financial chaos. And that was a straightforward bankruptcy, not the uncontrolled failure of an institution that many say it was.

Bailing out the insurers will still likely draw some of the same fire that has hit AIG in recent weeks. But economists say the government has decided it has no choice but bail out insurers since their bankruptcy would be a catastrophe. Unlike banks, whose failure is engineered by the FDIC and which is a tried and tested process in the US, insurers are not regulated at a federal level. Instead, they are regulated by each state where they operate, and so in the event one fails, up to 50 different regulatory authorities would be battling over how to divide them up to pay back policyholders, never mind bondholders and shareholders. This is why AIG has a gun to Geithner's temple.

No matter how you slice it though, one simple way to look at this is that the US government has created the world's largest sovereign wealth fund, a US$700 billion leviathan backed up with a printing press at the Federal Reserve that is churning out billions more in credit - including another $1 trillion last month alone. This new fund, the TARP, is being used to buy stakes in banks, carmakers and now insurers. So far, they are all in the US, but the purchases are bailing out shareholders outside the US, particularly sovereign wealth funds in China, and the Gulf. Some are being diluted by their new bedfellows from Washington, but sharing the wealth seems preferable to having no wealth at all.

The Fed has taken on the role once occupied by Fannie and Freddie, providing credit to goose the home-lending market, even as its purchases of US Treasuries allow the government to keep borrowing with abandon. In the process, the US government is taking the private sector's risk onto its balance sheet, a process that is feeding a return of risk appetite among global investors, even as the global economic outlook dims.

This is fuelling a rally in emerging markets, as well as a growing revival of the decoupling chorus. A new groundswell of optimistic reports are battling doomsayers over the fate of the Chinese economy, with some arguing that fiscal stimulus and rising bank lending signal a return of decoupling. The doomsayers say government-mandated bank lending to state-owned enterprises doesn't mean anything and that 6.5 per cent forecasted growth for China is recessionary. Falling Chinese demand for imports could have a deleterious effect on the global economy, they warn, particularly the commodities sector.

If it doesn't worry you that the state is going to have a stranglehold on the way capital is allocated in the world's largest economy, then it won't bother you that the SEC is trying to rig the stock market by placing restrictions on short selling. Add to this revelations that Chinese and Russian spies have been infiltrating the US power grid, planting sleeper programs that they could activate in times of conflict to disrupt or take over US power plants, and you have the makings for a pretty paranoid American public. Yet President Obama has decided to press ahead with liberalising the US immigration system, creating avenues for illegal immigrants to become legal. This is a sound policy, one true to America's original ideal as a refuge for the world's most industrious, but is likely to strike an electorate worried about a diminishing number of jobs as incongruous with their needs. Mr Obama's more immediate concern is in Somalia, where the US Navy has arrived to rescue a US ship captain being held hostage. Much of the region will doubtless be watching to see how tough Mr Obama is with black, Muslim criminals.

While Obama's new international diplomacy is taking a conciliatory approach towards traditional US foes like Iran's Ahmedinejad and drawing in allies to discuss Iran's nuclear programme in a departure from Bush unilateralism, it becoming clear that Mr Obama is also not prepared to accept the kind of erosion of US sovereignty that would enable it to embrace international accords on global warming. While it is willing to put things in warmer, more inclusive terms, the US clearly remains determined to set the global agenda, not adhere to one set elsewhere.

Where new immigration procedures are needed is the UAE. Joblessness still means repatriation. As difficult as it is to see a world in which unemployed foreigners become part of the landscape, the prospect of losing 5 per cent of the population this year to the recession has dire economic implications. warnold@thenational.ae