Of mice and politicians

It's been a while. Sorry about the delay. I intended to update over the holidays, then over MLK weekend, but the best laid plans of mice and economists....

The last few weeks have brought a plethora of speculation regardingwhat President Obama's economic stimulus package and bank bailout plan will look like. Over the next few blogs I intend to give a preview of possibilities, and then comment on them, once they are unveiled. Whatever your thoughts, keep in mind that both candidates were basically going to do the same thing regarding banks and the economy. both candidates supported and lobbied for the initial bank bailout and both said they were going to spend hundreds of billions of dollars to help homeowners and stimulate the economy. Some details were different, but the approaches were essentially the same. And the approach is what I will concentrate on, because, as you will see, no one is really sure about the numbers.

Since I am a banker (Please don't throw rotten tomatoes. You'll mess up your screen), I'll start with the bank bailout. If you have read the other blogs you will know that I do not agree with theapproach the initial bailout plan took. In addition, I do not agree with any of the changes that have been made. My feeling, and that of many prominent economists is that since toxic housing assets are the root cause of this mess we are in, banks must write them off their balance sheets. while this may cause some banks to fail, that is necessary to bring confidence back to the economy. Banks complain that if they had to sell the assets in todays market, they wojuld take too much of a lose. That's the point, though. The market will define the price of the houses. When the price reaches a certain level (and no one knows what that level is) investors and home buyers will get back in the market. Any plan that involves keeping any toxic loans on the books will only prolong the crisis.

With that in mind, lets get to what might happen. The Obama administration has proposed setting up a bad bank in which the Treasury would buy the bad loans from banks and hold them. The theory is that if the bad loans are off their balance sheets banks will lend again. That may or may not be so. What is certain is that if the banks are allowed to lend again, they have no incentive to mend their ways. What has caused some banks to tighten their lending standards is the prospect of bad loans coming off their books. They could not take as much risk as they once did (and never should have), hence the somewhat misleading headlines about lending standards tightening. (most likely they are going back to what they always should have been) It is estimated that a bad bank would cost the tax payers $4 trillion (yes, that is a "t"). In addition, according to the Washington Post, the idea, as proposed, would allow the banks to set the price of the assets. As I recall, the market, not the investor should be setting the price of investments when they are sold. To his credit, Treasury Secretary Geithner is against setting up a bad bank. The debate has (finally) started to go against any policy that does not make banks write off the bad mortgages and related investments. In the same Washington Post article former Federal Reserve governor Frederic Mishkin said that "Tough decisions need to be made. You have to make sure that when all is said and doen, you actually have financial firms that are either healthy and the ones that are not healthy can't stay in business." I do not think that is a sentence, but you get the point.

As for the economic stimulus package passed by the House, it includes $544 billion in spending and $275 billion in tax cuts for a total package of $819 billion. The spending includes money to extend unemployment benefits, money for health care coverage for the unemployed, money for infrastructure improvements, and various other program expenditures. The tax cuts include tax credits for workers, children, homeowners, and college, as well as money to subsidize local school bonds and infrastructure projects. I'll try and touch on these in the next few blogs.

As always, thanks for taking the time to read this. I hope you find it helpful.