Economics Oct 7, 2008
October 7, 2008 § Leave a comment
Despite the so-called bailout plan passing the House of Representatives on Friday, there are obviously still some major strains to global financial markets, and it now appears as if commercial paper markets could be seizing up as well. How much of a help was the bailout plan, and where do you think things stand now?
The bill, first of all, in many dimensions is flawed. But leaving aside the flaws of the bill, there is a much more urgent problem that we’re facing right now. It is one of a generalized run on the short-term liabilities both of the banks, of the non-bank shadow system, and now of the corporate sector. In the case of the banks, there is the beginning of a silent run on the uninsured debts of the banking systems, which are still over $2 trillion despite the increased deposit insurance. Many institutions in the non-bank shadow financial system are also finding that they cannot roll over their debts. There is a situation of generalized panic and lack of trust in counterparties. And worst of all, at this point, the commercial paper [short-term debt issued by large banks and corporations] to the corporate sector, and other types of funding to the corporate sector, is frozen right now. That can tip a corporation into a situation of defaults. They might not be able to pay interest on maturing debts, they might not be able to roll over maturing debts, and they might not be able to finance their working capital. So we’re seeing a generalized liquidity run, and it’s something that this bill cannot directly address. It’s something that needs to be addressed with different sorts of tools.
What sorts of tools do you recommend? I see you’ve called for major coordinated interest-rate cuts, on the order of one hundred points across the board, in all major world economies.
That’s only part of the solution. It has to do with coordinated rate cuts, but it’s not obvious [even after the cuts] that liquidity is going to flow to those who need it. We need to do something slightly more radical than just an interest rate cut. Most likely the Fed will have either to guarantee all deposits on a temporary basis, since that’s the only way you can essentially stop a run. But since that requires legislation and it’s not obvious that Congress will pass a temporary blanket guarantee, the Fed has to stand ready to provide the liquidity to any bank that needs liquidity. So if there is a run on any bank, the Fed has to increase the money supply by as much as is needed to essentially prevent that particular institution from collapsing. That’s the first thing.
Pasted from <http://www.rgemonitor.com/blog/roubini>