x Abu Dhabi, UAESunday 21 January 2018

To a drowning man, every lifeguard's a looker

The moral hazard of the rescue package is not as high as it might initially seem.

We can only hope that an agreement on the US$700billion (Dh2.5 trillion) rescue package in the US revives the interbank market. With that accomplished, the more painstaking work can begin on recovering as much as possible for taxpayers from participating banks and ensuring that financial executives aren't getting a windfall from the bailout. With that, the election becomes as much about who might be the next treasury secretary as about who might be the next president. There are signs that the enormous cost of the package will hasten a shift out of dollars and into emerging market assets in a bet that growth in these economies will continue at a slower but still positive pace, affording some shelter from the recession in the developed economies. The West, moreover, is looking to the savings-rich East to help finance the bailout. A lot of talk has focused on sovereign wealth funds, but most of the burden would depend on central banks. These banks, which invest reserves in short-term liquid securities, will remain in the market for dollar-denominated assets. This is particularly true of the Gulf and China, which need to manage their currency rates against the US dollar. And as one participant in a session on the dollar at the World Economic Forum's meeting in Tianjin this weekend noted, the dollar is - for better or worse - still the dollar. Sovereign wealth funds, on the other hand, will be looking to balance their need for capital appreciation against their need to minimise risk. Rising yields on US debt may become attractive to them, but the risk of dollar depreciation may offset that. There is a debate raging, of course, over whether the US package is the best way to move forward, particularly over whether the US$700bn will succeed in righting the banks and if so, whether it unfairly bails them out without adequate compensation for taxpayers. While the proof of the pudding will be in the tasting, it seems to early to condemn this package. For starters, it is not technically a bailout. Offering to put up US$700bn to buy toxic securities is not the same as actually paying to buy them. No doubt the government will negotiate the price of the securities at some rate over what they would fetch in the market, which at this point is zero. Many of these securities, as I mentioned before, will appreciate in value once the market is revived, in which case the cost to the government will fall. Many have suggested the government should get equity in return for its purchases, which is a nice idea if you like having the government own the banking system. But by instead creating a market for MBS, the US government will force banks to either sell them or below book value or mark them to market, both of which will force banks to confront their capital adequacy and seek recapitalization on their own from either their existing shareholders, new investors or, failing that, fail. The moral hazard of the rescue package is therefore not as high as it might initially seem. warnold@thenational.ae