Reader's Contribution

THE ABSURD TIMES

Absurd Times:

My name is Stephen Zill and I am an Economics Instructor at De Anza College, Cupertino CA (and sometimes San Jose State). For the last three quarters I have written a column for the De Anza school paper (La Voz). Inter alia, I attempt to keep it "student friendly", and to inject a bit of humor when possible-- lately this [dark-type, anyway] has been pretty easy. Anyway after hitting your blog a few times, I thought you might get a kick out the column I wrote about what was supposed to be the final bank/credit market- bail out plan. I would be interested in any comments you might have.

Cordially,
Stephen Zill
Economics Dept.
De Anza College

4) A discussion with the dark lord on the Fed's new deal (Pub. 10.27.08)

By: Stephen Zill

Posted: 12/1/08

It appears that the Federal Government has FINALLY settled on a plan - TARP II, or is it III? - that will be implemented in an effort to save our ailing credit markets and keep the economy from sliding into a deep and prolonged recession.

As a result, I have lately begun to immerse myself in a number of articles to learn more about the intricacies of the deal, and while doing my research, two things stood out: it seems that the Treasury is no longer referred to as THE Treasury, but simply "Treasury" (fascinating); and the other thing is, the cliché used most commonly when discussing the particulars of the plan is always, "the devil's in the details."

Thus, it occurred to me that, the Treasury thing aside, this "devil" fellow must know quite a bit about the present situation. So I figured I could save myself some trouble by simply giving the Prince of Darkness a call. (I have a direct line ... surprised? Come now, I'm an economics instructor!)

I put together a list of questions likely being asked about the Fed's new scheme and dialed up the beast to talk about it. I was put on hold, which seemed to last forever - probably due to the endless stream of Barry Manilow being pumped over the line - and then finally, ol' Mephistopheles picked up. What follows are the highlights of our little Q and A.

Beelzebub: Hell-o?

Me: You really need to work on some new material.

B: What do you want?

Me: It's about my weekly column in La Voz Weekly - Economics for Everyone? I figured it would be as good a time as any to give the details on what seems to be, more or less, the so-called "bailout plan" that the United States government has pieced together, as I am sure you've heard all about. And I figured, based on all the souls you've no doubt collected from Washington and Wall Street, who'd know more about this sort of thing than you? So can I trouble you for a few moments of your time?

B: I've got eternity. Shoot.

Me: Thank you. So, besides the much-publicized $700 billion that will be used to buy preferred bank stock, and to maybe purchase bad debt - aka "toxic paper" - what else is included in the plan?

B: According to last week's La Voz - yes, I read it; I'm a big fan - you've already told your readers about the dramatic scene where Treasury Secretary Henry "The Godfather" Paulson gave the heads of nine major banks "a deal they could not refuse". Having been chosen to volunteer for the program which features the $250 billion "capital injection" by way of preferred stock purchases, the banks - which include Bank of America, Wells Fargo, Citigroup Inc. and others - would, as long as they were part of the deal, have restrictions on their senior executives' pay, be forced to avoid compensation programs that "encourage unnecessary risks," and, of course, there will be no more of that "golden parachute" nonsense ... [here the phone is muffled; can hear voices but not what is being said].

Sorry about that. Just some new arrivals. Lawyers, sports agents, the usual. Where was I? Oh, and the FDIC will do their part by offering unlimited deposit insurance for non-interest-bearing accounts, and (for a fee) will back for three years some debts issued not only by banks, but thrifts and holding companies as well.

Me: Back to the $700 billion. Initially, Paulson was reluctant to take the "capital injection" approach, and instead hoped to free up credit markets by buying up all the bad debt that was clogging the system. Though the government will probably use some of our tax dollars to do just that, many believe the "capital injection" method is superior to the "cash for trash" method. Why?

B: Where do you want me to start? For one thing, it is considered to be more direct, hence more effective in getting banks to start doing business again. Another reason is that, due to their preoccupation with "moral hazards," the government instead created a "morale hazard," because whenever they stepped in for a takeover, or to facilitate a takeover, the stockholders got the short end of the stick. This contributed to the "run" on stocks, and created even more uncertainty and instability than we were already trying to deal with. And ideally, it is more likely that, by emphasizing that approach, the taxpayers could actually come out ahead.

Me: Do you really believe that?

B: [loud, prolonged diabolical laughter]

Me: Alright, what's so important about the LIBOR?

B: The LIBOR (London Interbank Offered Rate) is the rate of interest that banks charge each other for short-term loans. A lot of important lending rates are based on the LIBOR, such as adjustable-rate mortgages. It has been slowly moving downward lately, and the TED spread seems to be closing a bit. These are positive signs that maybe credit markets are starting to thaw.

Me: Maybe we should send the credit markets down your way.

B: Funny.

Me: Wait a minute ... TED spread? Is that something I can put on toast when I have my morning coffee?

B: No, you idiot. It's the difference between the short-term LIBOR and the interest rate on short-term U.S. Treasuries. It's a good gauge as to the health of the credit markets. Historically, the spread tends to be around 0.3 percent (or 30 basis points), while just a few days ago it went up to 4.65 percent (465 basis points). Scary!

Me: You should know.

B: Silence, mortal. Anyway, like I said, the gap has closed some, which is potentially a good sign.

Me: But everybody keeps saying we're already broke! $700 billion? Where's that coming from?!

B: Silly man. For one thing, like recent Economics Nobel Prize winner Paul Krugman (he owes me BIG TIME) said in an interview the other day, that is unlikely to be a problem. For one thing, you people have the largest economy in the world, and hence, the largest tax base. In addition, you can just simply keep on borrowing, because, believe it or not, foreigners are still very willing to keep buying up U.S. government securities.

Me: Okay, my phone is starting to get warm, so one last thing: do you think this plan is going to work?

B: All by itself, perhaps not. Already there are signs that banks have taken those first cash infusions and used them to pad their mattresses. They have also made little effort to debunk the notion that they may just use that cash to buy up their weaker competitors. As much as the Treasury has emphasized that the money they are getting is to be loaned, they have no legal right to enforce it. Therefore, consistent with the Government's "fling it at the wall" approach, I'm sure if this plan doesn't do the trick, other things will be tried. Already, the Fed has a plan to buy up to $600 billion in short-term debt, and there is talk of Congress putting together yet another fiscal stimulus package along the lines of the one that was passed last February. Anything else?

Me: No, I'm good. Thanks again. If I think of anything, I'll call you.

B: Feel free. Oh, and before I forget, be sure to take good care of that soul of yours. After all, we've a deal, you and I.

Me: Yeah, yeah. [click]

So there you have it - just in time for Halloween, the devil and the details.

Happy trick-or-treating, everyone.

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