There are two problems:
1. Willingness to lend.
2. Ability to borrow.Thus far efforts to unfreeze credit has centered around re-capitalizing banks and creating a market for otherwise unmarketable securities to reduce the fear of lending. The next discussed and tentative step of creating a "bad bank" does more of the same. This is good; but it is not enough for it does not nurture future borrowers to health.
For credit to flow, both banks and borrowers need to be healthy. For borrowers to be healthy, there must be income streams to service debt. The Obama American Recovery and Reinvestment Act is a good first step in the right direction; but more can be done through the treasury actions.
What I am hoping to see from Treasury Secretary Geitner is further action to create well capitalized "good banks" while at the same time addressing the ability to borrow side of the equation. This crisis arose for a simple reason; borrowers assumed stable and rising asset prices would help in discharge of debt obligations. When asset prices ceased to act as expected, there were insufficient cash flows to service and pay down debt. Responsible borrowing occurs when the debt undertaken can be paid down and serviced from future cash flows; borrowing in excess of this level means consuming now what belongs to the future - and then the future arrives.Moving the impaired debt into a bad bank works because it leaves behind adequately capitalized "good banks" - this addresses the willingness to lend factor. But for it to work better, the "bad bank" needs to re-structure/write-down impaired debt to a level where the borrowers future cash flows shall be sufficient to service the re-structured debt level. This will go a long way in restoring borrowers to health and stopping an otherwise unstoppable downward spiral in asset prices.Of course private capital working alongside the goverment funding of $350 billion will make it more effective - private capital flowing to "good banks" once bad assets are removed can be expected. However, private capital in "bad banks" is a very viable proposition provided the non performing assets acquired are re-structured and valued at a level providing an investor an expectation of a decent rate of return.So how to finance it. In the present circumstances the United States cannot finance government spending through taxes; equally it is likely that financing spending using further foreign debt will be unsuccessful. That leaves seigniorage (creation of money by printing it!) as the only real option; this is a dis-tasteful option, nevertheless in the present situation it makes sense of a kind. Since significant US$ debt is held overseas, financing government spending through seigniorage, coupled with a large subsequent devaluation is no bad thing. No doubt it will be inflationary; however this effect will be partly offset by the deflationary impact of de-leveraging.
What I am hoping to see from Treasury Secretary Geitner is further action to create well capitalized "good banks" while at the same time addressing the ability to borrow side of the equation. This crisis arose for a simple reason; borrowers assumed stable and rising asset prices would help in discharge of debt obligations. When asset prices ceased to act as expected, there were insufficient cash flows to service and pay down debt. Responsible borrowing occurs when the debt undertaken can be paid down and serviced from future cash flows; borrowing in excess of this level means consuming now what belongs to the future - and then the future arrives.Moving the impaired debt into a bad bank works because it leaves behind adequately capitalized "good banks" - this addresses the willingness to lend factor. But for it to work better, the "bad bank" needs to re-structure/write-down impaired debt to a level where the borrowers future cash flows shall be sufficient to service the re-structured debt level. This will go a long way in restoring borrowers to health and stopping an otherwise unstoppable downward spiral in asset prices.Of course private capital working alongside the goverment funding of $350 billion will make it more effective - private capital flowing to "good banks" once bad assets are removed can be expected. However, private capital in "bad banks" is a very viable proposition provided the non performing assets acquired are re-structured and valued at a level providing an investor an expectation of a decent rate of return.So how to finance it. In the present circumstances the United States cannot finance government spending through taxes; equally it is likely that financing spending using further foreign debt will be unsuccessful. That leaves seigniorage (creation of money by printing it!) as the only real option; this is a dis-tasteful option, nevertheless in the present situation it makes sense of a kind. Since significant US$ debt is held overseas, financing government spending through seigniorage, coupled with a large subsequent devaluation is no bad thing. No doubt it will be inflationary; however this effect will be partly offset by the deflationary impact of de-leveraging.
