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Everyone’s entitled to my opinion about the bank stress tests!

I’ve just spent a happy-go-lucky morning reviewing the Treasury’s bank stress test white paper.Humble little nothing-winning non-economist me believes that the stress tests are 98% government PR and 2% meaningful — which is a step up from just about everything coming out of the Bush White House. The stress tests were simply meant to calm jittery markets and buck up bank stocks and buck down bank bond interest rates. They are, in my most curmudgeonly humble position, simply a way to tell the American people that everything’s going to be okay now.

  • Justin Fox thinks capital doesn’t amount to a hill of beans as long as the government is guaranteeing bank liabilities.
  • Paul “Medalman” Krugman: stress test maybe, rigorous audit, no way. Of course, building up capital is child’s play when you can borrow from the government at 0% interest and lend that money out at 8, 9, 10% interest or more.
  • As an experienced test-giver, Mark Thoma says you can make your test give any results you want.

    I am, as usual, totally behind Kansas City Fed President Thomas Hoenig who advocates having a plan — plans are always good — for addressing the weakness of failing financial institutions rather than this willy-nilly higgledy-piggledy impromptu dance Bush and Obama have been doing the last few months. Part of the plan is obvious: failing institutions should be allowed to fail. Money quote:

  • Certain companies have not been allowed to fail and, as a result, the moral hazard problem has substantially worsened. Capitalism is a process of failure and renewal, and a “too big to fail” policy undermines this renewal and makes the financial system and our economy less efficient.
  • So-called “too big to fail” firms have been given a competitive advantage and, rather than being held accountable for their actions, they have actually been subsidised in becoming more economically and politically powerful.
  • The US government has poured billions of dollars into these firms without a defined resolution process, adding to our national debt. While there will be some repayment, there also will be losses. The longer resolution is postponed, the greater the losses and the larger the debt burden.
  • As these institutions are under repair, the Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role. This is reflected in the fact that its balance sheet continues to swell, which may compromise the independence of the Federal Reserve and make it more difficult to contain inflation in the years to come.
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