The London Interbank Overnight Rate (LIBOR) is supposed to be the definitive proof as to whether the credit markets are unfrozen. Over and over again, we have seen LIBOR touted as the bellweather for our “bailout” program. Give the banks enough money, the mantra says, and they will start lending to each other again. Once they do, credit markets will open up, and all the economic problems we are currently facing will go away. Business will be able to get loans again, consumers will be able to get loans again, and companies will be able to go into bankruptcy because they will be able to get debtor in possession financing again as they restructure. LIBOR will thus go up, because banks will be willing to lend to each other again. In other words, LIBOR is a performance measure for the functioning of the bank and bank to business lending portion of global financial systems.
I know a few things about performance measurement – it’s one of two non-scientific things I do as part of my job. Measuring how a system of discrete things, entities, people or agencies is working is not easy, and it does not lend itself well to the export of performance measurement schemes from one sector to another. Just ask any federal agency that is required to measure efficiency in terms of the increase in X units/percent of _________ created/enhanced/performed/completed for $Y Million under the federal PART rating scheme.
So when LIBOR was talked about as a performance measure to see if the bailout was working, I jumped on it. Granted, many of the best measures will be long term (like how well do banks do in keeping away from what we now call toxic mortgages), but in the short term, LIBOR seems better then the stock market.
All good things, right? Then why is LIBOR down around 29 % of its value 18 months ago? We’ve pumped $250 Billion into the banking and finance sectors since Congress authorized the bailout – which should have opened up credit markets and gotten lending going again. But it hasn’t. LIBOR’s wild ride between the collapse of Fannie Mae and Freddie Mac, and Treasury Secretary Paulson’s announcement that toxic assets won’t be bought proves it. And then, along come the auto makers to beg for what are essentially bridge loans to get them through tough times so they don’t have to declare bankruptcy. Add to that the CITIbank bailout proposed today, and I expect to see it go even lower based on its performance over the last two years.
So what does all this mean? Well, I think it means that the Treasuries plan NOT to buy toxic assets, but prop up failing financial institutions with toxic securities (or their underlying assets) is going to be a dismal failure. CITIBank is failing because it can’t get rid of it’s bad debt without writing off so much money that it will loose what little place it has in world financial markets. GM is failing for many reasons, but it floors me that GMAC’s mortgage unit (which I believe it sold off a few months ago) is not being pointed to as the money sucking leech that brought the company down. And like it or not, those toxic securities are still on the books of a number of banks, hedge funds, and other financial institutions. And as long as they are, LIBOR won’t go back up no matter how much money Treasury pumps into the system.
You see, while it may have surprised Alan Greenspan, it doesn’t surprise me that each bank put its survival and its profits ahead of the survival of the whole sector. They still are, mostly because no one – not Treasury, not Congress, not their corporate stockholders – is exacting a price from these banks for their bad decisions. Granted, those decisions were often made in response to policies run forth by both political parties over the last 15 years. But it is still no excuse. There is no moral hazard when you deregulate an industry or related industries, and then loan them money to cover for losses from taking advantage of those decisions.
So what to do? First, let’s keep measuring performance by LIBOR. IT shows a true picture (or as true as we can get) of how the financial system is functioning. And let’s get federal auditors going on sorting out those toxic securities. If we spent some of the bailout money to temporarily detail the thousands of federal auditors and contracts and financial specialists to review the books of each and every financial institution (and gave them IT support), my guess is that we would know in 3-4 months who owns what, and which debt is good and which debt is bad. Then the feds could help those with bad debt restructure. Those who just made bad decisions, failed to plan for the future, or entered into contracts that no longer work? We have courts and judges to handle that.
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