What a Mess!

Author: David Kotok, Post Date: October 1, 2008

What a mess!   And it is about to get worse.

Americans have repudiated both their 2-term Republican Administration’s leaders (Bush & Co.) and the Democrat Congressional leaders (Pelosi, Frank, and Dodd).  We have done so for good reason.  These politicians are neither trusted nor respected.  This is the result of their behaviors over the last few years.  The Congress has an approval rating so low that it is in competition with cockroaches and palmetto bugs.

Terrified House members voted “no” and broke with their party leaders.  Democrat Pelosi faced an out right leadership defeat so she gave “permission” to her party members to vote against her.  They were going to anyway.  Republican Boehner allowed his members to ”vote their conscious” and oppose him.  They were going to do it anyway. 

Query: shouldn’t Congressmen and woman always vote their conscience?  Should they have to ask for “permission?”

Because the voter, independent business man, retiree, and bank depositor is afraid, the rank and file American citizen has finally emerged from a cocoon and besieged Congress with an avalanche of “no”.   Members who face election only weeks away responded. And a lousy piece of legislation failed in the House.  Yes, it was a bad bill.  Yes, it had been improved from an even worse initial draft offered as the Dodd-Frank proposal.   Yes, it took away some of the blank check handed to the Secretary of the Treasury.  No, it did not go far enough.

Today the Senate will take the same lousy bill and add an increase in FDIC limits and some other Alternative Minimum Tax fixes and pass it with a wide majority.  Senators believe they are “safer” than Members of the House.  Only one-third of them stand for re-election at a time.   This Senate version is still a lousy bill.

Here’s why.  It takes cash and buys bad assets from the institutions who decide to participate.  Any institution that can avoid the constraints in this bill will try to do so.  Thus only the weakest will opt in as an act of desperation.  The others will languish and deteriorate until they, too, become so weak as to leave them without any choice.  This bill’s structure only prolongs and exacerbates the problems.   

The transfer of assets does not get banks additional capital.   It gets a liquidity substitution and that will help but it is capital that the banking system lacks and this plan doesn’t provide it.  Alternate plans offered in the House are addressing this serious deficiency. 

Meanwhile the banking industry is consolidating rapidly on its own.  The Federal Reserve is now aggressively adding liquidity at unprecedented levels in ways that were never previously contemplated.   Bernanke and Co. realize they must avoid a Depression.  They will succeed on the liquidity side. 

The solvency issue is different.  It takes new additions of capital.  And it takes recognition of loss.  The current plan that will be passed by the Senate gives some consideration of the later but it doesn’t solve the former.   That is the flaw. 

Raising the FDIC limits will help slow the “runs” that are occurring on banks.   But the limit of $250,000 is not a sufficient increase to protect an independent businessman who operates with a bank account balance that is in the uninsured zone.   That business is afraid of losing its money in a bank failure.   Hence the businessman is spending his efforts managing his bank deposits for safety rather than running his business.  He is just as human as the retired CD buyer who is now using a dozen different banks to stay federally insured.  Think about all the wasted effort being consumed to protect one’s cash instead of growing the economy.

The FDIC is now acting relatively quickly and competently in ways that lessen the losses to depositors.  FDIC folks know that every uninsured depositor loss now will have a heavy multiplier and create more havoc in a weakened banking system.  There is now visible and responsible action by this federal agency and they are to be supported.

The problem is that banking is consolidating very rapidly.  The big three banks now have one-third of all the deposits in the country.   There will be a lot more consolidation before this turmoil period is over.  That means the smaller regional and local banks must fill a local service provision needed by their local customers.  This is a business opportunity for those banks but they must seize it with adequate capital.   

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