Team Obama: Clueless

May 12, 2009 Editorial

Like all clichés, the one about America sneezing and the rest of the world catching a cold contains more than just a grain of truth. This importance of the US for global health arises primarily from the size of its economy, which provides a market for a great big chunk of the world’s production.
A drop in US demand and supply, as has been precipitated by its financial meltdown, can have a devastating impact on even economies like ours that are not particularly integrated into theirs, because of the interlinked globalised world economy.

What America does to extricate itself from its present mess, should be therefore of great interest to us.
President Obama inherited the mess from his predecessor George Bush and with him having ample time to come up with a game-plan, there were great expectations that he and his team would have hit the ground running with bold new initiatives in the key crisis areas.

The first, and arguably the most important one, was the financial sector that was the epicentre of the collapse. Sadly, now that we are past the first hundred days of the new administration it has become obvious that beneath the tough-love rhetoric, Team Obama appears as clueless as President Bush’s since it is evidently working out of the same play-book that was totally ineffective.

From the beginning it was evident that because of their plunge into the heady world of derivatives, credit default swaps and sub prime mortgages many US banks, including some of the largest ones, had become insolvent rather than merely illiquid.
Continuing with the Bush administration’s policy to pump billions and billions into their balance sheets did nothing to free up credit and only reinforced their determination not to write down their “toxic” and other dubious assets.

Why should they when these “zombie” banks were now certain that Team Obama had concluded that they were “too big to fail”? Sooner or later they would be allowed to pull out their “toxic” assets as “plums”.
We had earlier commended the Obama administration in this space when they decided to apply “stress tests” to nineteen of the largest US banks to gauge their true condition and we thought that it might also have been a good idea for our local situation.

Team Obama has unfortunately made a mockery of the “stress tests” and it is now obvious that the whole exercise was a charade intended to boost public confidence in the banks. The banks were allowed to negotiate the whole process to ensure a positive outcome – while accepting that new billions from taxpayers’ pockets would be needed in the near term!

The more pernicious damage is to hopes that Team Obama was serious about instituting the regulatory and supervisory framework that were degutted by the Clinton and Bush administrations.
We will repeat what we have earlier advocated. Team Obama will have to muster up the guts to do a Roosevelt of 1933: nationalise the banks (some of them are already effectively nationalised but the government refuses to take control), fire nonperforming management, liquidate the stock-holders, write off the bad assets, get the bond holders to take a loss, reintroduce needed reforms re banking/investment rules, turn the banks around and send them on their way, FDIC-style.

But this will never be done because of the capture of Washington by Wall Street as represented by the triumph of the Wall Street trio of Geithner, Rubin and Summers over Volcker, the old reformer.
What this means for the rest of the world and us, is that Team Obama will continue to fund its trillion-dollar stimulus plan by stepping up the printing of greenbacks since China and the other surplus nations will increasingly shy away from purchasing US Treasuries. The “zombie” banks that will increasingly undermine the few solvent banks by undercutting them will not relieve the credit crunch – safe in the knowledge that Team Obama will be there to prop them up.
Expect the exportation of the consequent US inflation.