Wednesday, February 11, 2009

How Much is Enough ?

In case you were wondering that the title implied that this post will be about money, you're not too far off. But for this case, it's meant to ask how much money is required to "flood the system" to enable the USA to lift itself out of this persistent downturn. Just yesterday, the US$838 billion "Financial Stability Plan" was approved by the Senate and it was prepared by the new Obama Administration, with a speech delivered by the Treasury Secretary Mr. Timothy Geithner. The next step is for them to detail the use of the remaining US$350 billion of the original TARP (Troubled Asset Relief Program) fund of US$700 billion to get troubled assets off major banks' balance sheets to be able to allow them to lend again, as well as tackle the worst housing crisis since the Great Depression. Wow, seems like this new administration really has their hands full ! The question is: how much is enough, and what will the tipping point be ?

The issues here involve not just the banks, but also how to stimulate domestic spending in order to provide a fiscal boost to the economy as well as kick-start the dying housing market where foreclosures are mounting daily. So the US Government needs a three-prong approach, and admittedly it's not easy being where they are due to the fact that such a situation is unprecedented (with the closest comparison being the Great Depression of the 30's) and requires many untried and untested methods to solve. So far, the Bush Administration kept on getting it wrong by doing stuff which did not help, but in fact was blamed for worsening the crisis (and causing the collapse of Lehman Brothers in October 2008). The reason being that no one really knew the effective way of saving the financial system as a result of excessive and wanton leverage, and so everything was being thrown at the system to try to see which would work. Apparently, this did not go down too well, with the result that the Obama Administration has to work to pick up the pieces of the shattered plan(s) and come up with some new, bold initiatives of their own.

In assessing how much is enough, one must question if there is currently ample liquidity flowing through the banking and financial system for normal credit to flow and markets to function normally. Liquidity is being constrained because of banks' tattered Balance Sheets, which make other banks hesitant to lend for fear of the loans becoming NPL; while loans to corporations have also dried up due to fears of companies not being able to service the principle and interest due to waning demand for products and services. It's a vicious cycle which feeds on itself, and only Government intervention through the injection of money into the system can counteract such effects. Thus, one might be tempted to place a dollar value on this crisis, whether it be US$800 billion, US$1 trillion or even as much as US$10 trillion (a truly astounding number, no doubt !). However, my view is that it is not just a matter of liquidity, but also one of confidence. Restoring the mental capacity of banks, hedge funds and private equity funds to invest and keep credit flowing is paramount, and it's a matter of sending them to a psychologist who will counsel their problems away and allay their fears, providing reassurances that "things will be all right". The reality is that everyone knows the world has gone topsy-turvy, and so such advice tends to fall on deaf ears and the same problem crops up repeatedly, one of fear, trepidation and anxiety.

So if such a systemic failure to get credit moving continues to persist, what will become of the world and of the financial system ? One should rightly assume that if the entire system seizes up, it's like a person's body going into spasms and all its muscles and nerves freezing up, meaning the person cannot move at all ! Imagine a petrified mummified person who has his "acu-points" blocked in those kungfu movies, and perhaps the image becomes clearer. People out there have to know that enough is being done to unclog the financial system and restart the lending, so that confidence is restored and liquidity can start to flow again. It's a pretty contentious thought - that a stimulus package needs to be big and bold enough to just kick-start confidence, and a positive feedback loop can then ensue to ensure the world recovers, albeit slowly.

Of course, as mentioned, thawing out the credit markets is but one step towards an eventual recovery. The other 2 aspects would be consumer spending and the property market in the USA. As of this writing, unemployment rate is the USA is officially at 7.6%, and is tipped to rise to double-digits as the recession worsens. With people losing their jobs at an alarming rate, no one is quite in the mood to spend, resulting in the retail and auto-mobile industries suffering crushing losses amid rapidly declining sales. The US Government has to get the people to start consuming again, as the irony is that the "Paradox of Thrift" would become a vicious cycle which will cause the economy to sink further into recession. In this aspect, Governments have to do their part to inject fiscal stimuli such as tax breaks, food vouchers or assistance programs to alleviate the pain of the common man. With retrenchments, mass layoffs and pay cuts on the rise, spending will be severely curtailed and may not rise again for at least several quarters; or until the job market stabilizes and companies have cut enough costs.

The entire tangled mess actually began from the sub-prime crisis, which in turn impacted home values and led to mass foreclosures. Housing prices have fallen into a tailspin and as of this writing, have not yet stabilized; thus it is imperative for the US Government to come up with a plan to stabilize home prices and to make homes more affordable to the general public, so as to reduce the over-supply of homes which is causing prices to plunge. It would be interesting to observe in the coming weeks the plans being formulated to tackle the housing crisis. Some possible suggestions would be to lower interest rates further to make home loans more affordable, and to make refinancing easier so that each person pays a lower monthly installment.

After all that's said and done, one must know that money is not always the solution. It takes confidence, courage and quite a lot of pain and suffering before recovery can take place. Obama mentions that "tough love" must be applied to banks, and I fully agree ! There must be a lot of pain involved in deleveraging (like cutting an infected pus-filled wound away from the body) before banks can declare themselves "clean" and start lending again. Though the recovery may be long and slow, it is nevertheless interesting to watch and learn. For learn we must, in order for history to not repeat itself !


Ricky said...

What Obama preaches and what he actually does doesn't seem to tally. The more the US government tried to meddle with the market, the more it plunges. But the pressure on him to do something is enormous. The best thing to let markets find its equilibrium is simply beyond him.

Tough love?

By printing more dollars?

Not by a long shot.

musicwhiz said...

Hi Ricky,

Actually I have a different view. The US Government is not directly interfering in the markets, but rather they are using fiscal stimuli to boost the economy. Of course, what Henry Paulson did had no effect whatsoever on improving conditions, and on hindsight it was all done in vain. Since the USA seem to be in a situation which is totally new, I would think no one knows what the "right" solution is and so they are just throwing all sorts of ideas out, hoping that one of them or a combination of them would work.

Markets will find their equilibrium definitely, but this has a lot to do with the housing market and the real economy as well as people's expectations of recovery. Currently, all seems bleak.

Printing more dollars is obviously NOT a good long-term solution but it's the only way they can shore up the balance sheets of banks at the moment. I am still waiting for a better idea to come out from these "experts". Mostly, it's deleveraging we are seeing now which is why it hurts so bad.