Are The Stress Tests Not Stressful Enough
One persistent criticism of the “stress test” process has been the argument that the scenarios being envisioned aren’t nearly pessimistic enough. Dean Baker makes the case:
2) Unemployment — in their negative scenario, the stress tests assumed a year-round average unemployment rate of 8.9 percent for the 2009 and 10.3 percent for 2010. The economy is on track to have a much higher unemployment rate, as it is likely to hit 9.0 percent in April. My best guess for a year-round average would be 9.4 percent for 2009 and probably around 10.5 percent for 2010. (These numbers assume no second stimulus, but of course Congress will not sit back and just let the unemployment rate go through the roof.)
3) House prices — the negative scenario assumes that house prices, as measured by the Case-Shiller 10-City index fall 22.0 percent in 2009. Prices in this index have been falling at a 24 percent annual rate in recent months. Given the massive inventory of unsold homes, It is reasonable to expect that this rate of price decline could continue at least through 2009.
I think Dean is probably too pessimistic about house prices. Still, to be as pessimistic as he is wouldn’t be unreasonable for an “adverse scenario” forecast. But the real trouble here is on the unemployment side. The evidence suggests that loss of income—primarily through job losses—is actually the main driver of home foreclosures. Home prices factor into the picture because price declines mean that those who otherwise might have been able to avoid foreclosure by selling their house may not be able to do. But the driver is on the jobs side. And the “stress test” employment forecasts seem way too optimistic. That said, it’s worth emphasizing that the Fed’s estimates of bank capital needs is pretty close to the IMF estimate so it’s not as if Ben Bernanke just made this up out of thin air.
That said, I’m not totally clear on how significant this will be. The stress tests are part of a strategy where it’s clear that regulatory forbearance and letting banks recapitalize themselves out of operating profits are playing a big role. Or in non-technical terms, as Paul Krugman says we’re going to be trying to muddle through. The results of the stress tests represent the limits of the extent to which pure muddling through will be allowed. But I think the right way to understand this is as a regulatory fiat—”forbearance will be extended to all those who do x, y, and z”—rather than as a proclamation about objective reality. If unemployment winds up much higher than the stress tests are forecasting, that will be a problem because so many people will be unemployed, not because the test will be “wrong.”
The question is how well can muddling through really work? If you’d asked a year ago, the conventional wisdom was that muddling through was a disaster for Japan and a catastrophic error that policymakers would never again make. But the deeper America’s waded into crisis, the better and better muddling through has come to look to politically constrained policymakers.
50 Responses to “Are The Stress Tests Not Stressful Enough”
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May 8th, 2009 at 10:49 am
Given that Dean has been one of the few honest economists for several years, and has among the most enviable forecasting records, is your statement that I think Dean is probably too pessimistic about house prices based on a hunch, or do you have an argument. If the latter, enlighten us please.
May 8th, 2009 at 10:57 am
These very good points are being made everywhere this morning. I’ll note a hint of dissent from Ryan Avent.
I have many, many questions about the stress tests and what banks will do to satisfy their capital requirements. In particular, The Underpants Gnomes at BOA seem to be peddling a plan predicated on the words ‘might,’ ’should,’ and ‘maybe.’ If BOA raises the full $34 Billion without significant further investment from the Treasury, I’ll eat my shoes. Some of the other plans I’ve been reading about this morning lean this way too. Something tells me that the Bank of America will be the Bank Owned by America by Christmas.
May 8th, 2009 at 10:58 am
Isn’t another wave of foreclosures on the horizon? <–not an economist
May 8th, 2009 at 11:00 am
On employment:
I think we are hoping that as the stimulus kicks in, the employment trough will flatten out a bit, such that the “more adverse” scenario for employment (which pretty much everyone recognizes is the new “baseline” scenario) ends up being more realistic than it would currently appear. And there is a very tentative sign of that happening: although it seems very likely that employment will still be worse in this quarter than the “more adverse” scenario assumed, the gap won’t be as bad as it was in the first quarter, and we may be on track for the gap closing completely by the end of this year, and maybe we will even beat the 2010 “more adverse” numbers by a bit. But we shall see.
On the banks:
I really think at this point the whole Sweden versus Japan thing is completely useless. We aren’t really doing what Japan did, and in fact we are doing more of what Sweden did than some people (on both sides) would like to admit. But the bottomline is that we have come up with our own approach, for good or ill.
In any event, as always, I will point out this plan isn’t just about political constraints. If this plan works–and admittedly it remains an “if”–then the necessary recapitalization and reorganization of the banks will be accomplished at a relatively low cost to the government (we may even make a small profit). And since that would be a good thing, I remain convinced it is worth trying.
May 8th, 2009 at 11:00 am
roboticghost, whether intentionally or not (i can’t tell), puts his finger on the key point.
the purpose of the stress tests wasn’t to forsee what happens if the world continues to rapidly go to shit (well, ok, returns to rapidly going to shit, since it is now slowly going to shit); it was to avoid taking anyone into full receivership at this time.
i think we will muddle through on the bank front and have thought so for a while; it’s the employment front that worries me….
May 8th, 2009 at 11:05 am
RoboticGhost,
BoA is trying to avoid a conversion of TARP preferred into common, which it may well fail in doing (although you never know: if it can sell some assets at a good price and continue to generate significant new cash reserves out of revenues, it might just barely pull it off). I’m not sure, though, that BoA is going to need entirely new government capital, even if its efforts fall short.
May 8th, 2009 at 11:06 am
Oh, you mean the greatest poverty-creating vehicle in this history of humanity agrees that everythings great?
That makes me feel better!
Maybe the IMF should stick to destabilizing Pakistan and countries in South Ameria.
May 8th, 2009 at 11:07 am
“…politically constrained policymakers.”
Or, what some of us call folks owned by bankers (Dodd, Schumer, Frank, Obama, Geithner, Summers, Rubin, etc.)
May 8th, 2009 at 11:08 am
1) I’m kinda worried about how this affects the political calculus involved involved in dealing with swine flu. And potential signs of how that calculation is shaking out.
2)The problem with flu containment measures is that they hurt GDP –and we have some Major campaign donors ..er.. financial service firms in the Intensive Care Unit at the moment. Robust Quarantine measures may push the feeble economy off the cliff. And make that $10 Trillion gamble with taxpayer funds (loans, guarantees,TARP,etc) turn to crap.
So you see attempts being made to instill confidence in the stock market. Consider Northwestern study being puffed on May 1 saying our “worst case” number of victims by May 28 will only be around 1700 — which I think would strike anyone familiar with exponential growth as absurd.
3) But if you take it easy and let the flu spread, you are killing 30,000 or High Risk people (asthma, diabetics,etc.) Maybe more. Maybe a lot more.
4) Which would nicely revive the Republican Party. After all, only 4500 lives were lost grabbing those oil deposits for the boys in Houston. You could lose that many in one day if this flu turns bads.
5) Gee, I know. Let’s promote an urban legend about “swine flu parties” and blame the stupid soccer moms. The ones who aren’t Republican are Hillary supporters.
http://search.yahoo.com/search?p=swine+flu+parties&fr=yfp-t-501&toggle=1&cop=mss&ei=UTF-8
May 8th, 2009 at 11:09 am
There are no ‘political’ contraints.
Politicians could murder bankers in the floor of congress, and they would probably increase their margins of the vote.
What you all REALLY mean to say is ‘Corruption constraints’. Because that’s what we’re really talking about here. These politicians aren’t afraid of losing their jobs, sucking banker dick is a lot more likely to make that happen than not getting banker money. What we’re talking about here is politicians afraid they won’t get cushy jobs when they leave congress, and might not get as many bribes while in office.
May 8th, 2009 at 11:12 am
Consider Northwestern study being puffed on May 1 saying our “worst case” number of victims by May 28 will only be around 1700 — which I think would strike anyone familiar with exponential growth as absurd.
Don, you’ll be happy to know that I am in the business of selling “swine-flu” insurance. For only 10,000, my team of scientists can guarantee with 99.99% accuracy that you will not die of swine flu.
Get at me before prices rise.
May 8th, 2009 at 11:12 am
That’s euros, not dollars. Sorry for any confusion. But hurry up quick before it’s too late!
May 8th, 2009 at 11:13 am
OBama is not constrained by political calculation. If the world really worked like that, FDR and GWB would be tarred and feathered for having been arm-twisting assholes.
Obama is contrained because he is corrupt. He adheres to a corrupt ideology that believes what is good for Goldman Sachs is good for America. He could care less if it’s goof for Americans. He’s just a lying hack who promised us affordable healthcare, a repeal of DADT, that he wouldn’t vote for FISA, that he was going to put the people ahead of greedy corporations, and that he was a good man. None of that turned out to be true, because he felt the need to use all of his political capital to funnel treasure money into pockets of his biggest campaign donors.
May 8th, 2009 at 11:14 am
DTM, can you share some of your stash?
May 8th, 2009 at 11:18 am
Econobuzz,
Even Krugman is admitting now this MIGHT work. So maybe you can ask him for a hit.
May 8th, 2009 at 11:21 am
Re DTM “Even Krugman is admitting now this MIGHT work. So maybe you can ask him for a hit.”
——————-
We would have but Krugman Bogarts the joint.
May 8th, 2009 at 11:22 am
Stress tests are a public relations exercise. The regulators are required to be up-to-date on banks’ books on a regular, on-going basis.
The major banks have been insolvent for a while now. The administration is just trying hard not to aadmit that.
May 8th, 2009 at 11:23 am
We would have but Krugman Bogarts the joint.
Well, he is an economist after all.
May 8th, 2009 at 11:45 am
Sure, if by ‘work’ you mean ‘prop up insolvent banks long enough for the next crisis to require another huge bailout’. then sure, it might work.
I’m willing to bet that most people wouldn’t define success as kicking the failure can down the road 5 years. As long as we don’t do something to reduce the power of banks in our society, this is all going to happen again very soon.
May 8th, 2009 at 11:53 am
Stress tests are a public relations exercise. The regulators are required to be up-to-date on banks’ books on a regular, on-going basis.
The major banks have been insolvent for a while now. The administration is just trying hard not to aadmit that.
As I understand it the stress test are more thorough and intrusive than what the regulators usually do, certainly more than what they’ve been doing during the last decade of lax conservative rule.
Matt links to Krugman’s column for today and Krugman asks the big question, what will the new financial regulations look like? Of course Krugman is always in carping mode so he believes they won’t happen but Obama has been pretty busy lately and did promise regulations for this year.
If the banks are insolvent, then this will become apparent as time goes on, but as DTM pointed out the US and other countries have done more than what the Japanese did in 90s when they “muddled through.”
May 8th, 2009 at 11:54 am
Sure, if by ‘work’ you mean ‘prop up insolvent banks long enough for the next crisis to require another huge bailout’. then sure, it might work.
I’d define the bank plan as “working” if it gets the banks back to desirable lending rates (both in terms of spreads and volumes) when the economy enters recovery.
In my view, preventing future crises of this magnitude is primarily a matter of regulatory reform. History teaches that there simply is no substitute for direct, strict, and coercive regulation of banks. Basically, you have to keep them from taking excess risks by pointing a gun at them and keeping it there.
May 8th, 2009 at 11:58 am
As I understand it the stress test are more thorough and intrusive than what the regulators usually do, certainly more than what they’ve been doing during the last decade of lax conservative rule.
At a minimum this was a much more comprehensive effort at a single time than the regulators have ever done–they periodically stress test individual firms in particular areas, but nothing like cutting across all major areas of all the major firms at once.
I also think you are likely right that the regulators have been way too lax in the past even when doing their mini-stress-tests, but that is harder to prove definitively. That, however, would be a good thing for a commission looking into the causes of the financial crisis to review.
May 8th, 2009 at 11:59 am
DTM, good luck getting regulatory reform at this point.
The banks will just say ’see, everything worked out great! No need to change anything!’ Obama’s corrupt ass will go along with them, and nothing will change.
We had to break the bankers power now if what you suggest would have ever worked. I’d imagine you know that, and that you really don’t want anything to change, so you argue a go-slow approach.
May 8th, 2009 at 12:01 pm
Whenever someone proposes a comission, they are proposing doing nothing. Talk is not action, no matter how convenient it is for you to pretend otherwise.
May 8th, 2009 at 12:04 pm
Remember how my wide-eyed projections of swine flu growth were ridiculed back on May 4? When we had only 286 cases but I pointed out the nature of exponential growth functions and make some forecast for the next few weeks?
Well, we are just coming up on the May 8 waypoint. My calculation was 1293 flu cases by today.
CDC just put out today’s release on number of US flu cases:
http://www.cdc.gov/h1n1flu/
Looks like I need to revise my model — we may hit those 200 Million cases two days early–by June 20.
http://yglesias.thinkprogress.org/archives/2009/05/tonights-homework.php#comment-1590550
May 8th, 2009 at 12:12 pm
DTM, good luck getting regulatory reform at this point.
We’ll see.
May 8th, 2009 at 12:52 pm
DTM, i wouldn’t waste my time on soullite’s cheap cynicism, which is in a bubble right now.
but i would be careful about defining success as back to desirable lending rates in terms of volume in a recovery: what’s likely to be different in this recovery is that it will be less consumer-driven than the norm and so overcapacity will remain in many lines of business while risk-taking will be less.
May 8th, 2009 at 1:12 pm
DTM, i wouldn’t waste my time on soullite’s cheap cynicism, which is in a bubble right now.
I agree, don’t feed the trolls even if soullite is sincere in his cheap cynicism.
but i would be careful about defining success as back to desirable lending rates in terms of volume in a recovery: what’s likely to be different in this recovery is that it will be less consumer-driven than the norm and so overcapacity will remain in many lines of business while risk-taking will be less.
I agree again and the open question is how much the government will step-up to replace the consumer (or provide funds to the consumer). People will continue to complain about the deficit (think of the children! The children!)
Once things turn around the banks will start making money hand over fist again.
Seeing how well Obama did on the budget and the stimulus and how he made the speech about building your house on rock instead of sand, regulations could be decent. Krugman’s default mode is to criticize so it’s becoming like the kid who cried wolf.
May 8th, 2009 at 1:19 pm
The big banks have gotten most of the almost $600 billion doled out so far, they get free money from the Fed to loan out, their bonds are guaranteed by FDIC and the FED is covering commercial paper because they can’t. And they still need more capital.
What kind of solvent is that?
May 8th, 2009 at 1:47 pm
DTM, i wouldn’t waste my time on soullite’s cheap cynicism, which is in a bubble right now.
Fair enough, although “we’ll see” is more or less my way of indicating that I don’t see much point in further conversation.
but i would be careful about defining success as back to desirable lending rates in terms of volume in a recovery: what’s likely to be different in this recovery is that it will be less consumer-driven than the norm and so overcapacity will remain in many lines of business while risk-taking will be less.
Also fair enough, although I originally wrote “back to normal” and then changed that to “back to desirable” for more or less this reason. But I should have scrubbed the “back to” formulation entirely. The point I was making was just that the success of the banking plan in particular should be measured by whether or not the credit markets are causing additional friction during the recovery. If not, then the plan “worked”.
That said, I think sometimes people overestimate how much of a reduction in personal consumption as a percentage of GDP we are likely to see. Public spending as a percentage of GDP is likely to increase somewhat, but it would have to increase far more than plausible for it to do more than slightly dent personal consumption as a percentage of GDP, and some of that increase in government spending as a percentage of GDP will likely be absorbed by a decline in trade as a percentage of GDP anyway.
Of course people are rightly pointing out that personal savings rates are going to need to remain significantly higher than they recently were, which combined with what I just pointed out potentially implies we are just screwed and bound for an L-shaped recession. But I personally think with some smart policies we could see more real income growth showing up among more potential consumers, which would allow both increased savings rates and increased personal consumption at the same time.
Krugman’s default mode is to criticize so it’s becoming like the kid who cried wolf.
I actually think it is fine if Krugman and others like him keep pushing for Obama to act more boldly–it helps move the Overton Window in positive directions. I just think it is better when such critics focus on substance (e.g., the stimulus should be bigger, we should be moving more quickly to recapitalize banks, and so forth) than process (e.g., Obama isn’t being mean enough to Republicans) or character (e.g., Obama is a corporate stooge).
May 8th, 2009 at 1:53 pm
I’m sorry but this is all so fucking ridiculous. There is no “policy” here — except in the tautological sense that not having a policy is itself a policy. It’s a disgrace.
Give the folks who caused the problem a trillion or more dollars with virtually no reform in return, let them borrow at 0% and lend to whomever they want at whatever rate they want, let them value — and thereby hide — hundreds of billions in toxic assets, subsidize sleazeballs to buy the toxic assets with taxpayer subsidies, and hope that a too-weak stimulus will save the economy — and rescue the banks at the same time. And sit by while Congress — bought and paid for by the banks — lets banks fuck average Americans.
Re-regulation? That’s a pipe dream.
May 8th, 2009 at 1:54 pm
And they still need more capital. What kind of solvent is that?
In this case, the additional capital is being required as a reserve against potential future losses. So the capital requirements are not being imposed because they can’t meet their debt obligations right now, and not even because their liabilities exceed their assets right now (although they might–part of the problem is that we don’t actually know the NPV of their assets right now). Hence, it isn’t really a judgment that the banks are insolvent (although again some of them might be balance sheet insolvent–we don’t know).
May 8th, 2009 at 2:05 pm
DTM-
If you are gonna bother to comment, why not answer the points made?
Like why did they need $600 billion if they were solvent?
Like why can’t they buy commercial paper if they are solvent?
Like why will nobody buy their bonds sans a guarantee?
Like why don’t they lend like crazy when they get the money for free?
May 8th, 2009 at 2:17 pm
DTM:
“I actually think it is fine if Krugman and others like him keep pushing for Obama to act more boldly–it helps move the Overton Window in positive directions. I just think it is better when such critics focus on substance (e.g., the stimulus should be bigger, we should be moving more quickly to recapitalize banks, and so forth) than process (e.g., Obama isn’t being mean enough to Republicans) or character (e.g., Obama is a corporate stooge).”
Yeah I agree, well put.
May 8th, 2009 at 2:29 pm
This covers at least 95% of the comments I’ve read on this blog on this topic.
May 8th, 2009 at 2:36 pm
Krugman’s editorial may have been the single most depressing thing I have ever read.
Three days after meeting with the President Krugman essentially disobeys a gag order to inform us there is no master plan being developed at the White House.
Krugman went into the meeting a skeptic and came out of the meeting convinced the administration has no clue what it is doing.
I know I was wrong. I believed there was a master plan. There isn’t. We are fucked.
May 8th, 2009 at 2:43 pm
If you are gonna bother to comment, why not answer the points made?
I thought I was, but I will try again:
Like why did they need $600 billion if they were solvent?
As a reserve against potential future losses. Again, please note this consistent with them MAYBE being balance sheet insolvent, but without us needing to know that they are. This, by the way, is the nature of banking regulation–we are not supposed to wait to step in until they are already insolvent, particularly not cash flow insolvent.
Like why can’t they buy commercial paper if they are solvent?
I’m actually not sure what your predicate claim is. But again, banks facing the possibility of future losses may curtail buying new risky assets as they try to build up reserves.
Like why will nobody buy their bonds sans a guarantee?
Inadequate capital reserves, plus uncertainty, could cause this effect.
Like why don’t they lend like crazy when they get the money for free?
Again, they are trying to increase reserves as opposed to simply increasing their holdings of risky assets. That said, they are in fact making big profits right now from their spreads, and originating at least some new loans. So we’ll have to see what is really the holdup here–maybe that Koo guy is right, and this is a demand-side effect.
Anyway, as a general answer, I think it is really important to understand that bank capital requirements are forward-looking, so a bank doesn’t have to be currently insolvent in order to voluntarily increase capital reserves, nor for a regulator to require a bank to do so.
May 8th, 2009 at 2:44 pm
This covers at least 95% of the comments I’ve read on this blog on this topic.
And about 5% of the comments you have personally written.
May 8th, 2009 at 2:51 pm
Max424,
Actually, I thought Krugman’s most recent article as applied to the bailout was noticeably softer in tone. He obviously still isn’t cheerleading for the Administration, but he does describe the Administration as having a “strategy”, and he admits “[i]t’s a strategy that might work.” He then claims “there are many things that could go wrong,” and it is hard to argue with that per se (although I would quibble with the odds he is suggesting, and I also think he is understating the degree to which the government will participate in any upside).
Of course then he gets into the regulation part, and on that . . . well, we’ll see.
May 8th, 2009 at 2:57 pm
max424, not for the first time, DTM beats me to what i wanted to say, so i’ll add that i thought it was huge that krugman said “might work,” since up until now krugman’s position has been that the only thing that could work is receivership….
and like DTM, you bet i want krugman to remain shrill….
May 8th, 2009 at 3:01 pm
to pick up on the “lending like crazy,” loan demand is down.
if people aren’t buying cars, aren’t buying houses, are shifting to using debit cards instead of credit cards, there just isn’t going to be as much consumer loan demand.
and if businesses don’t see final demand but instead see overcapacity and winnowing down to come, there just isn’t going to be as much business loan demand.
this is what DTM and i are talking about in terms of defining success: demand side is more likely going to be problematic than supply side in terms of loans.
May 8th, 2009 at 3:06 pm
DTM-
Thanks for the response.
1. This is almost a tautology. If you are solvent you don’t need capital- by definition.
2. Commercial paper was a routine part of the business until recently. So they stopped doing normal lending.
3. So the market doubts their solvency enough that they won’t buy their bonds.
4. If this is a demand-side effect, then all that talk about “frozen credit ” was bullshit.
And finally: If this is forward-looking, and they received $600 billion, and now they need more, then it is a good bet that they were billions under water in September.
There is more with regard to the ledgerdemain employed by the government, but I get tired of it. As you probably do also.
May 8th, 2009 at 3:17 pm
This is almost a tautology. If you are solvent you don’t need capital- by definition.
This isn’t a definitional issue, it is a regulatory one. Banking regulators make banks hold excess capital in reserve.
Commercial paper was a routine part of the business until recently. So they stopped doing normal lending.
There is absolutely no doubt that things were very much not normal in the financial industry, and indeed that things are not normal now. But you don’t actually need insolvency to explain that fact.
So the market doubts their solvency enough that they won’t buy their bonds.
Yes, but their potential future solvency, not their present solvency.
If this is a demand-side effect, then all that talk about “frozen credit ” was bullshit.
Yes, but of course it could be some of both. As I noted elsewhere, I’m not sure Koo’s analysis of Japan applies to the U.S., and I don’t think we can really know for sure until spreads come down a bit more and the economy is in recovery. If lending is still way below what we think is needed at that point, then there will be clear evidence of a demand-side effect of the kind Koo is suggesting.
And finally: If this is forward-looking, and they received $600 billion, and now they need more, then it is a good bet that they were billions under water in September.
No, that assumes they have actually used up their capital reserves in the interim, which is incorrect. This remains a concern about whether their capital reserves are adequate going forward, but so far their revenues are actually outpacing their losses.
May 8th, 2009 at 3:42 pm
“Banking regulators make banks hold excess capital in reserve.”
This is not only nonresponsive- it is also false.
May 8th, 2009 at 4:17 pm
Ron, why do you keep saying the banks have gotten $600 billion? I think the 19 banks that were stress-tested got a total of $216 billion. Where’s the extra $400 billion that you’re talking about?
May 8th, 2009 at 4:59 pm
K. Williams:
$700 – $109 = $591
http://www.thestreet.com/story/10488841/geithner-1096-billion-left-in-tarp-funds.html
As I said:
“The big banks have gotten most of the almost $600 billion doled out so far”
I would include the AIG amount, as it has gone to counterparties.
May 8th, 2009 at 6:05 pm
@39 DTM & @40 howard:
Krugman’s editorial could not have been more pessimistic. What he is saying, quite clearly, is that if Obama’s “muddle through” strategy works perfectly, if a whole series of random events -by sheer happenstance- perform like synchronized gears in an intricate Swiss made watch, then Big Finance will survive and be allowed to return to doing business as usual.
That is the best case scenario! No systemic changes have been contemplated for a system that has imploded. The maximum achievable goal is to put Humpty Dumpty back together again place him back up on the wall.
Krugman doesn’t go into detail on possible worst case scenarios. He just tells us to be “very, very, afraid.”
I will hold on to one ridiculous hope/fantasy. Obama has a master master plan, and has told Krugman to continue blasting him because it is helpful politically. Krugman’s new role is to be the administration’s economic secret agent.
May 8th, 2009 at 8:02 pm
This is not only nonresponsive- it is also false.
I honestly don’t know why you are claiming that.
You’ve got a bank with a certain amount of liabilities in terms of things like deposits and other loans to the bank. Then you have some assets of the bank. The regulators won’t let the assets match those non-capital liabilities, even though that would technically let the bank be balance sheet solvent. Instead, they are going to make the bank’s assets match those non-capital liabilities plus some amount of capital. That is because there is some risk of non-performance by the assets, and we really, really don’t like banks becoming cash-flow insolvent–in fact, we don’t even like people thinking a bank might become cash-flow insolvent. So, the capital is there as a reserve against such losses, such that the bank will remain cash-flow solvent even if those losses show up, and that everyone will believe that is true.
All right, so suppose the regulators are getting nervous about the magnitude of the losses a bank’s assets might be facing in the future. They might as a result require the bank to increase its capital. That doesn’t mean the bank was currently insolvent–again, it might have been meeting all its current cash flow obligations, and its old assets might still have met its old capital plus non-capital liabilities. Rather, they may make this change solely because they think more capital is necessary to make sure the bank won’t become cash flow insolvent in the future, and to make sure everyone believes that.
May 8th, 2009 at 8:11 pm
Max424,
As a long-time reader of Krugman, I honestly think that counts as him being optimistic when it comes to Obama. Yes, he is making it sound like the odds are against Obama’s plan working, but that there is any chance at all of it working is a big concession for him.
Then there is the part at the end, starting with:
But what worries me most about the way policy is going isn’t any of these things. It’s my sense that the prospects for fundamental financial reform are fading.
To be blunt, I don’t think anyone should pay any particular attention to Krugman when it comes to political questions like this. Seriously, he is an excellent economist, but I don’t think he has any special knowledge or particularly good instincts when it comes to politics. And also to be blunt, the evidence he offers for this proposition–some vague comment by some guy who was being considered for a Treasury position but then withdrew–is ludicrously thin.
But that is Krugman for you. And in any event, I am fine with him pushing for action on the regulatory side, subject to the preference for criticisms based on substance (versus process or character) that I noted above.
May 9th, 2009 at 10:18 am
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