Monday, January 05, 2009

Dealing with toxic assets - the only three alternatives

A friend kindly writes:

"Dear Prabhu
"It has been great to listen to you speak on PBS online and also to read your letter to Barack Obama. You have provided a wonderful oversight of the economic global crisis in terms of what must be done - I see predominantly lots of comments analysing without proposing. And of course it all comes with a sense of how God's heart is hurting as those at the bottom suffer most.
"Some questions. In London we read a great deal of the problems of inter-bank lending. You deal with this in passing. The dichotomy is that Gordon Brown wants the banks to recapitalise whilst continuing their 2007 lending patterns. So customers - business and individuals - suffer as banks hold onto cash. But acutely, the banks won't help each other out because of fear. Do you have ideas to get them lending to each other? Would forcing them to a confidential acknowledgement of their exposure to toxic debts help clear the air?
"regards as ever

Here is my response:

Dear David
many thanks for your kind response to the PBS interview (BTW did you listen also to the first broadcast that PBS did with me, back in 2004 if I recollect aright, titled "The Gods of Business"? - as far as I know, it was the most popular programme ever broadcast by PBS in that series)

inter-bank lending: "forcing banks to a confidential acknowledgement of their exposure to toxic debts" would indeed clear the air - in the sense that whoever the disclosure was made to (presumably the government) would then know exactly rather than merely generally as at present. However, the issue is not merely disclosure. The issue is what to do on the basis of the detailed information disclosed: some (or possibly many) financial institutions are in fact bankrupt when their toxic debts are taken into account.

There are only three possible solutions:

1. Wait for the market to gradually sort this out (Japan has pursued this path since 1990, and the market still has not been able to sort that out some 28 years later, with the effect that Japan - the world's second-largest economy! - has been stuck for all that time!)

2. Government could take on even more toxic assets (which means in fact you and I as taxpayers) - do "we" really want to do that? How much toxic debt do you and I want to take on? Why?

3. All such toxic activity could simply be declared illegal and the liabilities made irrecoverable except for the amounts originally invested. I favour this option because that hurts the speculators sufficiently without hurting the ordinary citizen. It is important to avoid hurting speculators so much that they all go bankrupt - if they did all become bankrupt, that would also hurt you and I as taxpayers, because all the employees of the affected organisations would be made redundant and at least some of them (perhaps many of them) would become "social cases" dependent on government handouts (i.e. one handouts from taxpayers). Such bankruptcies would, of course, have consequences for pension funds, as well as create the risk of system failure if one or more large players go under from continuing full exposure to their toxic liabilities.

It is not only a matter of *my* "preferring" option 3. It is the only option that makes sense, so far as I can see.

prabhu Sphere: Related Content

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