The Treasury, in what the Wall Street Journal called an “unusual announcement,” today proclaimed that it was able to use the $700 billion allocated last week to invest “directly in troubled companies” to “strengthen the balance sheet of individual institutions.” The Journal continued, “Such a move, however, is likely only to occur if a firm is teetering on the brink of collapse and poses a systemic risk to the financial sector, according to people familiar with the matter.”
The purpose of a recapitalization is to get banks lending again. Insolvent banks will effectively “stuff the capital in the mattress,” because they will still not have sufficient capital to extend credit. But, it seems, to acknowledge that some assets are not worthwhile and some institutions are not solvent in this day and age seems just plain mean-spirited. Aren’t we all winners? Don’t we all get a trophy? No.
Insolvent institutions need to be culled from the herd and now is the time. We have an additional $700 billion to offer solvent institutions to carve up the carcasses. Existing regulatory institutions, while far from perfect, have adequate authority and powers to resolve the current market crisis. Let’s close the offending financial institutions, ring-fence the bad assets, bolster the capital of solvent institutions, and move on to restore economic growth. Will it be costly? Yes. Debilitating? No.
Hundreds of billions of dollars are waiting on the sidelines for want of market direction devoid of random government interference. Those funds are ready to buy failed financial institutions and their worthwhile assets. They are ready to invest in solvent institutions that will use the money to lend for mortgages, student loans, small business loans, and all the types of credit that has been decried as “paralyzed” as of late.
While the economy is not where we’d like it, at best we have just entered recession. Even if this does become the “worst recession since the Great Depression” (which, itself requires portending the future), that remains a far cry from double-digit unemployment – much less the Great Depression’s twenty-five percent unemployment – or GDP cut by roughly half.
This will be a pretty much run-of-the-mill recession. Keeping markets locked up in denial, however, will keep us in recession. Japan’s lost decade wasn’t caused by realizing losses and moving on – it was caused by refusing to realize losses and maintaining zombie banks that did not have the capacity to lend. We can repeat those mistakes if we want to but, as the saying goes, “the definition of insanity is doing the same thing over and over again and expecting different results.”