Banks in Trouble

An excellent op-ed in Friday's Wall Street Journal (which I can't access on the web) explained the credit crunch problem well to me, and why the Fed has so far been unable to solve it.

The problem is that banks don't trust each other. Therefore, it's clear that there is another shoe to drop. Banks have expanded their risks enormously because they used securitization (selling loans as some kind of paper) to get loans off of their books. If the loans stayed on their books, the banks would have been limited in their loan making by their capital and their access to funds. Once banks were close to being limited in making loans by the size of their capital, the Fed could regulate new lending by expanding or limiting the banks access to additional funds.

If they moved the loans off of their books, however, they were never limited. Furthermore, at least in theory, moving the loans off of their books also moved the risk off. But now all of this junk that the banks thought they had gotten rid of is coming back home. Citibank has recently taken several of the "SIV" off-books sham entities it created back onto its own books, thus limiting the amount of new lending it can do.

To the extend that Citibank or other banks become capital limited, the Fed can help in its traditional way. However, if the majority of the loans are floating around as commercial paper being held by who knows who, there is not much the Fed can do. In essence the banks created money that was beyond the control of the Fed.

The rub is that the banks know how much trash is out there, because they know how much trash they sold. Therefore, banks are reluctant to lend to other banks, because they don't trust the other bank to stay solvent to repay the loan. The scary thing is that the banks know better than anybody what risk is out there, and they are too scared to lend to their colleagues. That makes it look bad.

Everybody talks about the subprime housing crisis, but what if there is other bad stuff out there. Banks have been "securitizing" everything, getting loans off their books. What about credit card debt? Car loans? Business loans? If banks lowered their lending standards considerably in these other sectors as they did for mortgages, won't some of them start to go belly up, too?

Paul Krugman has an article in the NYT saying that we are in more than a liquidity crisis. A liquidity crisis is when you have the capacity to pay off a loan, but you just don't have the cash on you. In this case, somebody (the Fed) can loan you the money to pay it off now, and then you can pay them (the Fed) off later as you continue to get salary paychecks, or your house finally sells, or whatever. But if you can never pay off the loan, it's a different problem. The money is gone for good. In this case the banks may have paid themselves huge profits on bad loans in a giant ponzi scheme. If the debtor can never pay, a Fed loan is not going to help. It may be that the banks believe this, and that's why they won't lend to each other.

If only a small percentage of the loans are bad, the system can handle it, but at some point this could grow from a liquidity crisis into a financial crisis.

Chalabi's Back

Ahmad Chalabi is back in power in Iraq. I had been wondering what happened to him. The LA Times reports that he is now in charge of restoring the Baghdad infrastructure -- electricity, water, trash collection, etc. No doubt he is using to good personal advantage his ability to give away politically valuable stuff that is paid for by someone else, probably the US. Since he was one of the main people responsible for starting the Iraq war, it is not surprising that he is benefiting from it. His ability to make Bush, Cheney, Rumsfeld and Wolfowitz his puppets who danced to his instructions showed how clever he is. Now, to come back like the phoenix from the ashes of his banishment from Baghdad shows it again. It probably does not bode well for Iraq, since Chalabi is much more interested in helping himself than in helping Iraq. It just shows how American policy in Iraq has failed, failed, failed, while Chalabi has won, won, won at America's expense, figuratively and literally.

How Are Services in Baghdad?

There has been a lot of press about how well the surge is working in Baghdad and how many people are returning from Syria and Jordan. But how well is the reconstruction of the Iraqi infrastructure going? Until now, a major problem has been security. We couldn't build things like sewage plants, electrical generation stations, etc., because people kept getting killed working on them. Now what's it like? How many hours do Baghdad residents have electricity? Do they have water?

The other question is what has happened to the neighborhoods? Has violence dropped because the neighborhoods have been ethnically cleansed, because neighborhoods that were once mixed Sunni and Shiite are now only one or the other?

And, has the violence dropped because we defeated al Qaeda and other opponents, or have they just faded into the woodwork until the surge is over? It appears that the surge is about over. Troops are coming home that are not being replaced, because there are no troops to replace them.

It looks like the surge proved that we needed more troops than we had for most of the war. Why did it take us four years to learn that? Just how bad are our military planners and leaders?

Bush Lessens US Standing in the World

The Financial Times had an excellent editorial saying that the US needs to make some more friends in the world to help it achieve its objectives. Bush loves to stick his finger in other countries' eyes and call for regime change, but it doesn't work that well, as Iraq illustrates. This editorial is apparently based on a a report by the Centre for Strategic and International Studies. It says, "One of the chief casualties of the Bush administration's foreign and security policies has been US standing in the world. This loss of reputation matters. In testing the limits of its 'hard power', the administration has sacrificed precious 'soft power' resources too. It hurts the country that so many people around the world no longer trust it to act responsibly, and that (according to a recent BBC poll of 26,000 people in 25 countries) one in two says the US is playing a mainly negative role in the world."

It adds, "Dethrone the 'war on terror' as the organising principle of US action - not because containing terrorism is unimportant, but because subordinating everything to that aim makes it harder to achieve."

But in general, even of the this report, the FT says, "there is a whiff of hubris about it."