With talk this morning of a plan for the Fed to set up Special Purpose Vehicles -- remember Enron? -- to buy up Commercial Paper (CP), a shrinking $1.6 trillion market of month long loans used to pay employees and buy inventory, we are now getting to the point where the Fed and the Treasury are the only bank that's still making loans. And with the new SPVs it looks like the Fed is running out of money to sop up all the financial toxic waste. The other banks seem to be frozen by fear. They borrow money from the Fed and clutch it to their breast, unable to trust that it they lend it to others that it will get paid back with interest.
But the good news for the time being is that the world still thinks of U.S. treasury bills as the safest place to park money. As a result, the Treasury can sell an apparently unlimited quantity of them to investors around the world and pay virtually no interest in the bargain. As long as this continues, it creates an opportunity to put that money to some positive use -- instead of throwing it at the world markets and watching value evaporate -- e.g., $2 trillion has disappeared since the $810 billion bailout bill to save us from heaven's wrath was about to pass.
The Fed could charter, say, 100 new banks around the country. These banks would be capitalized by a combination of money from the Treasury and private investors. Their deposits would be insured up to $250,000 and they would be required to lend out no more than $10 for every dollar of capital. They would be run by experienced bank executives who had been carefully vetted for their lending prudence. And because of their pristine balance sheets, they would be comfortable lending to each other -- knowing that they could get more capital if needed.
The 100 new banks would be able to fund CP rather than hoard it. And this would make the Fed's job much easier because it simply lacks the staff to be the single national repository of all decisions pertaining to issuing CP. By distributing this responsibility out to these 100 new banks, decisions would be better informed and be made more quickly.
And these new banks would reboot the financial system. Granted the weak banks would lose market share to these healthy new ones. And the free market or regulators would need to step in to find merger partners or close down those weak banks. But this approach would help revive credit markets while harvesting the banks that have been crippled by their bad credit decisions.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
10-07-2008 @ 12:05PM
Ed Doan said...
It seems to me that the feds did something sensible and necessary, when it became obvious that throwing cheap money to banks and promising to buy their bad debt wasn't freeing up any money. As you said, they just clutched it tightly to their chest. As least we are putting the money in the hands of business to KEEP them in business. That helps solve some of the immediate problem.
But then you go on about establishing new banks. I somehow don't see that as a quick fix, a near-term fix, or really a fix of any kind. The economy would truly be in shambles long before they could be realistically be formed. If your idea is a long term fix, then I propose that changing the charter of current banks would be more effective. It seems that the latter should be done anyway. The feds have their greasy fingerprints all over the current crisis evidence, so poking them into a few more things might make sense. I just don't want the govt to decide that it gives them the right to interfere in the day to day business of business.
10-07-2008 @ 12:25PM
Ed Doan said...
On a second subject, I don't understand how you and everyone else seems to think that $2 trillion dollars "evaporated" in the market decline. Let's try an example of how I think it works.
Let me back up to a few months ago....
Of the millions of shares outstanding in a company, many of them were bought a a fraction of the value the market says they're worth. I happily go around telling everybody how much I've made in the market. However, I really haven't made a penny until I sell. Now the market drops, and I feel like I lost money, but the stock is still worth more than I spent, I'm still money ahead...if I sell.
In other words, the "value" of a stock isn't real money except for those that enter the market at that value. The late entries, or those at the peak, lost real money, but you can't treat the overall reduction of stock price as real money. The $2 trillion is what would have been lost if every share were purchased at the peak, and a lot, if not most, wasn't. You live in the same delusiional world of the guy that bases his worth on the fictional paper value. You have to occasionally actually trade investments to realize any gain.
10-07-2008 @ 12:34PM
JCH said...
Sorry, what is absent is the government's fingerprints.