Page 2 of 2 The mother of all golden parachutes
By Hossein Askari and Noureddine Krichene
see that difficulties are temporary and have every interest in re-capitalizing
their institution, they will accept to inject new capital. If shareholders deem
that the financial viability of the institution has been irrevocably impaired,
then it is not the role of the government to maintain loss-making private
enterprises. As in any country, deposits have to be secured by the government,
as it is the only body that can issue licenses for banks.
Despite its initial defeat, TARP's proponents are reviving it to shed their
troubled assets, letting the government suffer the losses. The Bush
administration in its last days has avoided addressing the root cause of the
crisis, and has rejected sensible proposals advanced by opponent congressmen
for economic and financial stabilization. The administration has not considered
alternatives
that directly channel credit to productive sectors, for instance through credit
lines financed by the government and managed by banks.
Nor has the Bush administration requested funds for infrastructure, energy and
social sectors, requests that the US Congress would have certainly approved.
Bernanke and Paulson have formulated a plan that no banker could have dreamt of
or asked for. It was their pure invention and the proposal of such a plan has
had a detrimental effect. It has raised expectations, divided policymakers,
destabilized markets, and those who have interest have jumped on board.
By endorsing the Paulson-Bernanke plan, presidential candidates John McCain and
Barack Obama will extend, whichever becomes president, not for four more years,
but for a much longer time, the Bush administration's financial chaos. The new
administration will inherit, not only the largest fiscal and external deficits
in US history, but a huge fiscal debt at about 90% of gross domestic product
(GDP), and totally lose control of monetary policy, which cannot be reined in
without sending interest rates skyrocketing. The debt crisis may become even
more unsustainable if defaults continue, both nationally and internationally.
The gap between the Fed and the banking system has grown too large. The Fed is
still trying very hard to push banks to renew a credit boom, make people live
beyond their means, re-inflate the economy, and aggravate external deficits
with presumably the intention to strengthen the financial system and stimulate
the economy.
However, you can lead the horse to water, but you cannot make it drink. Bankers
are no longer in the mood to repeat the credit orgy of recent years and shower
loans that will never be recovered. Foreclosure studies show that in all
foreclosure cases, mortgages were totally irreconcilable with incomes,
absorbing at least 40% of gross income. There is no way for a family with
$40,000 per year to service a mortgage loan of $600,000 and above.
Besides banks becoming increasingly prudent, households have also become
reluctant to take on more financial burden. With credit increasing at very high
rate of 12% during 2001-2008, and total outstanding credit at 350% of GDP,
there is no way to avoid dramatic credit defaults in the event it becomes
harder to renew a credit boom. Repeating from the above, banks have the money
but they do not want to lend.
The financial disorder of Bernanke and his predecessor as chairman Alan
Greenspan over a decade cannot be fixed, and should not be fixed, in five
minutes time. A "quick and clean" bailout will certainly transfer huge wealth
to bankers and debtors, and will make them enjoy their wealth without paying
anything for it. As there is no real credit freeze to the productive sector of
the economy (that is, definitely excluding the housing sector), the TARP will
not address the present economic and financial problems of the US economy. It
will only worsen the macroeconomic imbalances.
It is a fact that central banks have largely exceeded their mandate of managing
liquidity in the economy and have evolved into the main bodies that manage all
of an economy. They have thus neglected the regulatory aspects and the control
of credit.
Subsequently, they have caused immense price distortions in the economy, as
reflected by negative real interest rates, exorbitant housing and commodity
prices, high energy and food inflation, and unstable exchange rates. Worse,
they have created a most uncertain economic environment. As the Nobel economist
Maurice Allais has put it: the whole world's financial markets have become
casino tables. Monetary policy has become entirely subordinated to financial
markets and turned as volatile as these markets. The notion of independent
central banking has totally vanished. It is impossible to make any sound
forecast or investment decision in such a volatile environment. It has only
become propitious for speculation.
The US Congress and governments in other industrial countries have to
reconsider the role of central banks if a degree of financial stability is to
be restored. Banks cannot be blamed for their troubled assets. They were misled
by imprudent monetary policy. Even at this late hour, Congress should not rush
into TARP. Acting under pressure from Wall Street and interest groups has only
worsened the economic and financial situation. Instead, Congress needs to
appoint a body of independent experts who will analyze carefully the causes
underlying the present financial crisis and formulate reforms that will
redefine the role and attributions of the central bank, rehabilitate the
financial sector, preserve lasting financial stability and promote
supply-oriented steady growth.
Demand-led growth goes through booms and busts, is highly inflationary and
causes immense price distortions and large internal and external imbalances.
The real income gains of the boom phase are more than offset by losses in the
down phase.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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