That Worked (?)

At last, our long wait to learn the Administration’s policy on banking is over.  The policy is: wait.This message comes from Bernanke, Geithner, and other officials over the past few days.  And, in this season of attempted policy message convergence within the G7 (it happens or tries to happen twice a year, ahead of the IMF/World Bank ministerial meetings), it is what we are starting to hear on all sides (e.g., from Trichet, head of the European Central Bank): we’ve done a lot, our economies might recover, and we don’t want to overdo it.  So we’ll wait.

Looking just at the US economy or just at the Eurozone, this might make sense.  But recognizing at what is heading our way from Eastern Europe and other rapidly slowing parts of the global economy, “the risks are weighted to the downside” (an official euphemism that you will hear frequently in the coming weeks).  And the market is not so easily convinced that all is now well or even significantly better.

Look at what happened to the credit default swap (CDS) spreads on US banks yesterday.

This is a small improvement, presumably because people feel somewhat comfortable that the Administration has no immediate intentions towards junior bank debt.  And the drumbeat of positive spin from Messrs. Pandit, Lewis, and Buffett is having some effect – these are smart people, and they only put out such encouraging public words when their private information indicates that things are going much better.

Yet there is a tendency these days, even among leading global CEOs, toward tunnel vision.  They see what is directly in front of them and do not want to focus on the storm clouds that are gathering a mile up the road.  The roof has a massive hole, a hurricane has definitely been sighted, but it is sunny today.  Should we talk about how sunny it is and how the hurricane might vear off, or should we undertake some rapid roof repairs?  Should we focus on the level of CDS spreads or the latest tiny tightening?

The prevailing G7 official tendency in such situations is always: wait and see.  Sometimes this is a great idea and works out just fine.  Now seems unlikely to be such a time – it is far too easy to be overtaken, massively and disastrously, by events.  Ask Hank Paulson about his experience in mid-September 2008.


Originally published at The Baseline Scenario and reproduced here with the author’s permission.