Wednesday, November 12, 2008

Rays of Light for Those Feeling Grouchy

Photo by willgame

If continued rockiness in the credit markets and broad economy have you (like me) feeling a bit grouchy, the convergence of a few news stories recently seems to offer cause for a bit of optimism.

LIBOR continues its downward trend, with the 3-month dollar rate setting this morning at 2.13%. On the one hand, this is oddly high, especially given that the money markets seem to be awash in liquidity, with investors shying away from auctions of year-end money from the Treasury! On the other hand, this is almost 275 bps better than during the vertigo-inducing days of the recent past. Incidentally, 3-month LIBOR has fallen in surprising parallel with gas prices, with the national average per gallon settling at a 21-month low yesterday of $2.20 per gallon. Good news already!

Despite this improvement, as I noted earlier, banks still are not passing this greater liquidity through to the markets that need it. Paulson today exhorted banks to step up and "play their necessary role to support economic activity," but one wonders how powerful this kind of rhetoric can be. If the banks took hundreds of billions from Treasury and hoarded it, knowing full well that the money was passed out to stimulate lending and offer the economy a much-needed liquidity infusion, what makes Paulson think his telling banks to lend will make a difference? I hope I'm wrong, and the banks will react to Paulson's entreaty, but call me a skeptic.

While Paulson's words don't offer me much hope, his deeds offer a little. He announced that the TARP program in its original design will be more or less scrapped, which looks a really good development. If banks want to deal with their "toxic" mortgages and MBS, they (and the servicers on the front lines of battling the foreclosure crisis) need to take a big, bitter dose of reality and start modifying mortgages to keep these properties out of foreclosure. Recent initiatives on this front announced by the biggest banks seem to represent a very positive step, as does the Freddie/Fannie push for modifications announced yesterday (though Alan White's criticism of that program seems compelling). In another great post, Alan points out why servicers, investors, and banks really need to get in line for a realistic haircut on these troubled loans, take responsibility for minimizing their own (and the broader economy's) losses, and clean up their own mess without externalizing these problems onto taxpayers and the economy.

Paulson's new plan for using the TARP facility seems to me to be better targeted toward fixing what really ails the U.S. economy now--consumer confidence, closed pocketbooks, and inability to get loans to leverage future earning capacity to support smoother current spending. This kind of consumer investment (spending) represents 2/3 of our economy, so juicing this sector sounds like a great idea. Again, more careful underwriting of consumer credit extension is clearly needed, but if liquidity is to find its way into the system to do the most good, the consumer portal seems like a more direct and immediately effective point of entry.

I am impressed by the agile and flexible way in which Paulson and the other managers of this rescue plan have considered options, quickly abandoned ones that didn't seem to work, and moved on to alternatives that offered better prospects. This resistance to getting bogged down by sunk costs and inertia is, it seems to me, the heart of vibrant entrepreneurialism. This kind of pragmatic flexibility is what has made the U.S. economy so great, in my view. I am hopeful that this kind of agile entrepreneurialism will bring us through these tough times.

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