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2009-04-17 08:39 by Karl Denninger
in Banking System Ignore this thread
Stiglitz Gets It

Yet another shot across the bow of The Obama Administration came out from Joseph Stiglitz yesterday:

April 17 (Bloomberg) -- The Obama administrations bank- rescue efforts will probably fail because the programs have been designed to help Wall Street rather than create a viable financial system, Nobel Prize-winning economist Joseph Stiglitz said.

All the ingredients they have so far are weak, and there are several missing ingredients, Stiglitz said in an interview yesterday. The people who designed the plans are either in the pocket of the banks or theyre incompetent.

Yep.

And what's his prescription?  Right here:

Rather than continually buying small stakes in banks, weaker banks should be put through a receivership where the shareholders of the banks are wiped out and the bondholders become the shareholders, using taxpayer money to keep the institutions functioning, he said.

On 9/30/2008 I released the following:

Once 1-3 are put in place then send in the OTS and OCC examiners and look at every financial institution in the United States. All who are insolvent and unable to raise private capital immediately are forced through receivership where the debt is converted to equity and existing equity is wiped out.

With the CDS monster caged the systemic risk is removed, the bondholders provide the cushion for recapitalization (as it should be) and the restructured firm emerges with no debt while the former bondholders are now the owners (of the equity) in the resulting firm.

Ding ding ding.

Indeed, if you go back to my Tickers in through 2007 and 2008, you will see this as a recurring theme - we already have the means to solve this and have since this crisis began.

It is called bankruptcy and the process inherently includes cramdowns of the equity structure.  That's what bankruptcy does!

What Mr. Stiglitz hasn't elucidated is why we have to do this way (and unfortunately we will, whether we do it earlier or later, with the only question being one of how much destruction our government will level on the broader economy first.)  That is, he gets the "why we're not" (regulatory capture and/or incompetence) but he's not talking about the mathematical necessity of doing the right thing.

The simple fact is that the overriding millstone around our necks as a nation is our debt-to-GDP ratio at all levels - in households, in businesses and in government.  The math makes sustainable recovery impossible until that ratio comes back into line with reason.  The longer we refuse to force the cramdowns and therefore extinguish that excessive debt, the longer this economic malaise and trouble will last.

Any recovery that government tries to manufacture through "allowing" balance sheet games and other forms of accounting trickery (which I consider to be nothing other than "looking the other way" fraud upon the public and investors) in the broader economy and capital markets will be fleeting and weak, simply setting up yet another leg downward in both.

The government attempted exactly what we're doing now in the 2000-03 recession and produced what "looked like" a strong economy for four years.  It was not; it was a chimera, a fraud and a scam, as everyone in America now can see; all we did was made the inevitable "bust" far worse than it would have been in 2000 if we had forced the debt out into the open and defaulted it then.

We have followed the same "prescription" since the late 1980s and it has failed.  I keep coming back to one of my favorite sayings:

Insanity: Doing the same thing over and over again but expecting a different result - Albert Einstein