The Stimulus Is Unimportant Compared To The Real Mess

Until the bank situation is resolved the stimulus can’t really help stimulate much at all. I have concerns about it specifically but everyone should recognize that it is just a drop in the bucket compared to the most pressing concern. So, how is their plan for that going? Let’s turn to the esteemed Yves Smith at Naked Capitalism (emphasis mine):

[Fiasco] That one word assessment of the Geithner plan, as previewed in the New York Times tonight, comes from reader Scott, and is good enough to print.

I am so disgusted with this entire proceeding that I am going to dispatch it quickly.

Let’s start with the basics. The US banking system is insolvent. Got that? Insolvent. That does not mean every bank in the US is toast, in fact quite a few are probably just fine, and another large group is no doubt hurting and undercapitalized, but a couple of years of not shooting themselves in the foot again would enable therm (via earnings) to rebuild their equity bases sufficiently to proceed more or less as normal.
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But the history of major banking crises unambiguously shows that insolvent financial institutions need to be resolved. There are variations on the theme: the government can take them over and recapitalize them, clean them up and re-sell them, a la Sweden; you can wipe out equity investors and bondholders; you can try new twists, like various good bank proposals that have surfaced lately (making new entities out of the deposits and good assets and leaving the dreck with the existing bond and shareholders). While there would be many important details to be sorted out, this is not path breaking, except in the scale at which it needs to occur. And now, having had four actute phases of a credit crunch, the Fed and other central banks have plenty of liquidity facilites ready to deal with any initial overreaction. Rest assured, although radical measures would not be pleasant or easy, there are plenty of models and precedents.

But…here we have another scowling Treasury secretary, with a bit more hair than his predecessor, serving up the same fatally flawed approach as before: let’s just throw money at the banks and hope they get better. This is tantamount to using antibiotics to treat gangrene. You waste good medicine and the progression of the rot threatens to kill the patient.
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In fact, the present course is the worst of all possible worlds. AIG has demonstrated that a player deemed to by systemically important has a blank check. Not only did they get additional dough with few questions asked, they got improved terms on their initial loans

And it goes on. Bottom line, this “plan” sucks, won’t materially change anything and the cost will be far more than they are talking about now.

Which brings me to a bailout update: Fannie/Freddie need $200 billion, GM/Chrysler may still have to declare bankruptcy and we have no idea how much we’re on the hook for for AIG because it’s too complicated to even figure out.

On the bright side, the 10 year bond has strengthened a lot today, which is very good if it holds. The stock market is down 4% but that is not nearly as important. Last week I was alarmed when the market was down as far and the bonds were selling off as well, because that is a very bad sign…

Update: The stock market is presently down 5%, the 10 year yield is down 0.2%, the dollar has strengthened 1.3% and 2.5% against the Euro and pound respectively and is down over 1.5% against the yen. In my view this is a resumption of the deflation trade and means that people’s initial reaction is that the government will not stop the deepening of the recession or increased trouble at the banks. Of course I view this as a positive thing because I think the problem is too big to fix, and it will allow us to invest in long term infrastructure more cheaply. However, if correct, it will also deepen the global recession and cause more unemployment, so it is pivotal that aid to the states and unemployed is sustained…which if I remember correctly was cut out of the Senate “compromise.”