Tuesday, March 24, 2009

The Economic Crisis: Can Geithner Hit A Moving Target?

Treasury Secretary Geithner's toxic asset purchase plan certainly buoyed the stock market when it was announced on Monday, March 23, 2009. The market rose almost 7%. Since the Geithner plan continues the Bush 43 administration's policy of socializing losses while privatizing gains, it's no surprise that the stock market--which reflects the value of the private sector--would have jumped. But the stock market is notoriously unreliable as a predictor of the future. After all, when the market reached its all time peak in October 2007, were we getting any signals that 18 months later, it would be down over 50%, to levels first reached in the mid-1990s? Today's drop of 1.5% (DJIA) to 2.5% (Nasdaq) may have indicated some second thoughts about the Geithner plan.

One thought that may not have gotten a lot of attention is that Geithner focused on a historical problem: the large hornet's nest of toxic assets left over from the collapse of the housing market and the credit bubble. These assets have been a herd of elephants in the living room, and understandably catch everyone's attention. But as the seas in the worldwide economy have gotten rougher, a lot of stuff has started slipping and sliding around on the deck. Much of it is overseas and may not command much coverage by the American press. Lack of press coverage, though, doesn't mean it's unimportant. Think back to how much attention credit default swaps got in June 2008, three months before the U.S. bailout of AIG. It wasn't much, although you could have read about them in our blog (see http://blogger.uncleleosden.com/2008/06/is-credit-default-indigestion-coming.html).

In addition to the toxic asset problem, we have European unwillingness to provide sizeable fiscal stimuli. European nations accept higher levels of unemployment and lower levels of economic growth than does America. The European toleration for stagnation will be a drag on U.S. efforts to re-ignite the economy. When President Obama goes to the G-20 meeting in early April, he'll find out that there won't be a reverse Marshall Plan.

In addition, the economies of Eastern Europe and the former Soviet Union are weakening. Recently, a Russian state owned aircraft leasing company (Finance Leasing Co.) defaulted on $250 million of bonds. That's not a large default, but the Russian government could have prevented it and chose not to. The default brings back very bad memories of Russia's 1998 currency crisis and bond defaults. Those events led to the near collapse of Long Term Capital Management, which could have brought down the world's banking system had the Federal Reserve not strong-armed the major banks into a bailout. The economic woes of Eastern Europe and the former Soviet Union could potentially take down large banks in Germany and Austria. Recall that the collapse of a major Austrian bank, Creditanstalt, precipitated a financial crisis in the early 1930s leading to the Great Depression.

In addition, China's government has proposed establishing a new international reserve currency to replace the dollar. While the Chinese government has also said it would continue to buy U.S. Treasury securities, ambiguity like this isn't accidental. A Chinese loss of confidence in the dollar will reverberate worldwide, and make it harder for the Treasury Dept. to borrow. That, in turn, would make it costlier for the government to provide cheap financing to purchasers of toxic assets. With China, Japan and other foreign nations now serving as America's bankers, let's remember that we need at least their implicit approval of any major deficit spending program. And they're mostly frowning these days.

It's easier to hit a stationary target than a moving one. Geithner may, or may not, have scored a hit with his toxic asset plan. We'll know soon enough. But economic conditions around the world continue to deteriorate, and other assets are becoming toxic. The overall target--restoration of economic health--is moving rapidly, and merely removing the current batch of toxic assets from bank balance sheets won't necessarily revive the credit markets if other factors continue to drive the economy down. The Bush 43 administration was repeatedly behind the curve, and arguably didn't hit targets much better than Dick Cheney with his shotgun. Geithner, President Obama and other world leaders need to swing their points of aim ahead of the moving targets and pull the trigger in time to score direct hits.

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