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Wednesday, January 07, 2009


political reality setting in

hopes have been high among optimists for the empowerment of barack obama as a vehicle toward mitigating the deepening global slump. there seems to be a consensus that a democrat will do anything, spend any sum, to get credit flowing again -- and will do so with the intellectual firepower of ben bernanke, tim geithner, paul krugman and many other devoted keynesian acolytes behind him.

i have reservations over the potential efficacy of government spending in the face of horribly crippled banks that badly need to be nationalized, sorted by triage, have assets marked down to worst-case valuations and then either be liquidated or be relieved of their bad assets and recapitalized. the actions of hank paulson to date unfortunately have come to represent yet another failure of the predatory administration of george w. bush, which being completely captured by financial interests has refused to wipe out stakeholders and cram down bondholders in forced debt-to-equity conversions. such steps -- brilliantly realized by sweden in its benchmark 1991 financial sector resolution -- taken here and in europe would, in combination with a CDS moratorium, end the crisis of the financial sector. but it isn't being done, i suspect largely because the consequences to vested interests would be terrible. paulson has instead more or less shamelessly used the rescue impetus as cover to directed funds to financial industry cronies without precondition. goldman sachs is the example, being paulson's former firm, which distributed as much in bonuses as it received in relief capital from the treasury.

will such healing steps finally be taken under the obama administration? many hope yes; i think no. not only is the democratic party almost equally captured by financial interests, but the administration will still have to deal with a rump, radicalized and paranoid republican party in the house and senate.

concessions to that faction are already in train. three data points:

  • obama recently announced the reconstitution of his proposed economic stimulus plan from a government-spending-heavy program of public works to a heavy weighting of middle class tax cuts.

    Making tax cuts such a large part of the stimulus may help win support from congressional Republicans. Senate Minority Leader Mitch McConnell, a Kentucky Republican, said his party would support an immediate middle-class tax cut as part of any stimulus package.

    “Republicans, by and large, think tax relief is a great way to get money to people immediately,” McConnell said yesterday on ABC’s “This Week.”

  • these concessions were in part the result of the growing realization that republicans can obstruct and delay the development of the legislation. the timetable for the stimulus bill to emerge from congress was once january 20. now it is being touted for sometime before the mid-february break. it remains to be seen if congress will even hit that deadline.

    Obama is slated to meet today with congressional leaders from both parties to discuss the plan. Democrats said Congress probably won’t be able to complete work on the plan by Jan. 20, the day of the inauguration, as some had hoped.

    “It’s going to be very difficult to get a package put together that early,” House Majority Leader Steny Hoyer said in an interview on “Fox News Sunday.” “We want to do this right.” Hoyer said he expects the House to pass the bill by the end of the month and get the legislation through the Senate and signed into law in February.

  • this morning, obama is further paring back promises. barney frank is talking about the 'principled' conditionality of bank rescue capital, which while short of nationalization would could at least offer the government leverage to reorganize recipient firms outside of an FDIC resolution. frank, however, seems less interested in creating such leverage than scoring populist political points.

    but perhaps more importantly obama himself interlaced warnings of massive fiscal deficits for many years to come with a message of fiscal rectitude, probably for congressional consumption.

    In his most explicit language on the subject since winning the election, Mr. Obama sought to reassure lawmakers and the financial markets that he was aware of the long-term dangers of running huge deficits and would take steps to limit and eventually reduce them.

    Big deficits force the government to borrow more money, saddling future generations with large financial burdens and leaving the nation reliant on foreign governments and other big investors to lend cash. The problem is even more acute now because credit markets, which in recent months have made it much harder and more expensive for businesses and individuals to borrow, could be further strained by financing a huge government deficit. ...

    “When the American people spoke last November, they were demanding change — change in policies that helped deliver the worst economic crisis that we’ve see since the Great Depression,” Mr. Obama told reporters at his transition offices. He added, “They were demanding that we restore a sense of responsibility and prudence to how we run our government.”

    But Republicans and some fiscally conservative Democrats have expressed concern that the need for a substantial economic stimulus plan could sweep away for years any serious effort to bring government spending into line with its revenues.

    While economists almost universally support running large deficits to combat the kind of steep recession the country is grappling with now, they are increasingly expressing alarm at the prospect of sustained fiscal imbalances heading into a period in which the aging of the population will create huge budgetary strains because of the growing costs of the Medicare and Social Security programs.

    Still, the deficit now seems likely to be so large that it will inevitably constrain Mr. Obama’s administration to some degree. At a minimum, it seems sure to force him to walk a line between maintaining the confidence of the financial markets, which could drive interest rates up sharply if they doubt his will or ability to improve the government’s financial condition in the long run, and various constituencies that will be pressing him to make good on his campaign promises.

meanwhile the treasury effect is already setting in, with consumer staple giant procter & gamble noting that its borrowing costs are rising as it competes with the united states government and others for funding, a dynamic which has seen even investment-grade corporate spreads blow out to all-time highs.

Investors are demanding yields relative to government debt near December’s record high of 6.56 percentage points for investment-grade issuers in the U.S. after the worst financial crisis since the Great Depression shook confidence and sent government borrowing costs to historic lows. Interest rates on investment-grade bonds hit their highest level since 1991.

“The new-issue premium is large and seemingly larger for the next deal,” said Tim Barker, London-based head of credit research at Aviva Investors, a unit of the U.K.’s second-largest insurer that manages about 2.4 billion pounds ($3.6 billion). “To get the deals away, they’re going to have to be priced cheaper each time.”

the effect is to compel corporates to cut dividends, conserve cash and pay down maturing debt -- further perpetuating the contraction of the money multiplier as borrowing demand slides.

UPDATE: krugman will go one further:

Bit by bit we’re getting information on the Obama stimulus plan, enough to start making back-of-the-envelope estimates of impact. The bottom line is this: we’re probably looking at a plan that will shave less than 2 percentage points off the average unemployment rate for the next two years, and possibly quite a lot less. This raises real concerns about whether the incoming administration is lowballing its plans in an attempt to get bipartisan consensus.

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