The US ‘Emergency Economic Stabilisation Act’ (EESA) was meant to save the world’s financial markets. Yet so far, the FTSE 100 has fallen by as much as 200 points today. The US markets are looking grim too, and as for the money markets, the Libor-OIS spread (as Bloomberg puts it, “a gauge of the scarcity of cash”) hit a fresh record – which doesn’t bode well.
So what’s the problem? Well, it seems that the EESA just hasn’t quite turned out to be the cure-all that some were hoping. Here’s what we’ve gleaned so far.
The EESA will give the US Treasury up to $700bn to buy mortgage-backed securities and other dodgy assets via the ‘Troubled Asset Relief Program’ or Tarp. The Act says that the Treasury should buy these assets “at the lowest price that the Secretary determines to be consistent with the purposes of this Act.”
Anyone participating, says Capital Economics, will have to “provide the government with equity warrants” (the right but not the obligation to buy shares in these companies). There are also limits on executive pay which are still being drawn up. The President will also have to submit legislation within the next five years, to recover any losses to taxpayers from the participants.
And that’s about it. Capital Economics says that “the scheme is better than nothing” but it “does very little to address the fundamental problem of the lack of bank capital.” The key problem, it seems, is that line about prices. No one actually knows exactly how prices for these assets will be set.
And the problem is, “the only way the Treasury’s plan would have any meaningful impact on bank capital is if it vastly overpaid for the securities are buying.” This would enable banks to book some profits from the sales, and then that would allow them to improve their balance sheets, and presumably lead to a pick-up in lending. The trouble is, that would be too much like the ordinary taxpayer bailing out Wall Street, and that’s the last thing that the politicians want to see happening.
In fact, DBS Group reckons this isn’t a bail-out at all.
The key issue is that this $700bn will still only deal with the liquidity problem – in other words, the fact that banks lack ready cash. It’ll buy up dodgy assets, but the banks will eventually have to repay in the end. “Banks will have to make good on any losses suffered by the government. Taxpayers will bear zero bailout cost. In economics, zero cost usually means zero value. Such seems true in this case.”
According to DBS, any bank whose only problem is liquidity can already get as much short-term liquidity as they want, without the strings attached, from the Federal Reserve. And a bank which is actually insolvent (its assets simply aren’t worth as much as it owes) will have to eventually pay back any overpayment it gets from the Fed. So, that’s not much help to them – “unless you have struck the jackpot in the meantime, you are still insolvent.”
The group reckons that all that will happen after this bail-out is pretty much “business as usual.” And at the moment, business as usual isn’t very inspiring. Insolvent banks will be taken over by the government, and illiquid banks will either merge with stronger partners or keep drawing on central bank help.
As Capital Economics puts it, “the bottom line is that the financial and economic imbalances have taken years to build up and may well take years to unwind… we still expect the economy to endure a torrid recession next year.” So no wonder the markets aren’t cheering.