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Imagining a Post Pandemic World

How might a post-pandemic world look and feel? Let’s imagine a creative team at a New York City advertising agency pitching a campaign in 2050 for a new perfume (more than most products, perfumes are sold by attaching to the dreams and aspirations of their times).  The Big Apple, ...

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RIP Credit as Money


Wednesday January 28, 2009

by Eugene Linden

The drumbeat about the Obama administration’s plans to fix the banking crisis has reached fever pitch. Over the past week, what appears to be a carefully choreographed series of leaks has raised expectations that the administration has something very big planned (my guess is that it would have been announced right after the inauguration, but for the delay in Timothy Geithner’s confirmation as Treasury Secretary). Various newspapers and blogs have speculated on the details, some of which would be truly dramatic: e.g. an omnibus take-over of a raft of banks, a process that would include wiping out existing shareholders, converting debt to equity (to avoid the new N-word – nationalization), the FDIC providing a backstop for deposits, and, to restore trust in bank balance sheets, the establishment of a new entity to buy, hold, and trade trillions of dollars in now-suspect bank assets.

Clearly something needs to be done, and just as clearly the banks have gotten wind of the proposals and are trying to head off the scariest parts of the plan (I interpret the trumpeted insider share purchases by Chase’s Jamie Dimon and execs at B of A to be a message: “hey, no need to nationalize us, we believe in our equity value!”). Ignored by much of the commentary, however, has been a small but crucial change in the proposed composition of the much-discussed new entity to buy toxic bank assets. Moreover, if this entity comes to pass, it will serve as the grave for a widely shared, but very dangerous artifact of the bubble years: the confusion of money as credit.

First the new wrinkle in the “bad bank” concept. Last week on CNBC Sheila Bair, the outgoing and incoming head of the FDIC, remarked on the possibility of setting up an entity funded by both public and private money to buy toxic assets. The involvement of private money is new, and the timing of this announcement begs many questions. In the CNBC interview Bair said, “One approach we think might have some merit is what we call an “aggregator bank” where you would set up a facility capitalized through some portion of the T.A.R.P. fund to acquire troubled assets…” So far so good, the basic idea has been floated many times over the past year. But then she remarked that the new structure would… “also require those institutions selling assets into this facility to contribute some capital cushion themselves…”

The suggestion about lenders having a stake in the entity is both crucial and new -- at least new to the Bush administration (a number of observers, including me, suggested such an entity at the beginning of the crisis in Aug. 2007: https://www.huffingtonpost.com/eugene-linden/collapse-of-a-fiat-curren_b_60562.html). Forcing banks to have skin in the game alongside taxpayers makes it less likely that financial institutions will try to screw the taxpayers. Having the government involved also provides adult supervision in the setting of the ground rules.

Why then didn’t the Bush administration put forth this key provision before the very end? Someone must have suggested it -- after all, it’s little more than common sense. If it’s a good idea in the full teeth of the crisis, why wasn’t it a good idea at the outset? That it will be the Obama administration that launches this entity implies that the Bush administration was loathe to push for the self-policing aspects of having the banks provide capital.

And then, there’s the end-of-an-era aspect of plan. Whether it’s called a “bad bank” or “aggregator” or “RTC II,” the new entity represents an explicit admission that no one else is willing to accept trillions of dollars in credit instruments that two years ago were treated as interchangeable with money. Thanks to the ingenuity of Wall Street’s rocket scientists, so-called structured credit products proliferated wildly during this decade, backed by mortgages and other obligations (or by other credit instruments that in turn were backed by assets). With credit rating agencies blessing these products as AAA, these instruments were treated almost as money, and provided much of the liquidity that spurred the illusion of wealth creation during the bubble years.

Now, pension funds, hedge funds, endowments, and financial institutions that confused money and credit have discovered -- in the most brutal fashion -- that the value of anything deemed to be money-good rests entirely on the willingness of someone else to accept it. With no one but the government willing to accept these assets, this former currency will be retired as scrap. RIP money as credit.

Unfortunately, the story does not end there. While officials cross their fingers that these disgraced credit instruments will remain quarantined, this nuclear waste could still leach into the financial system, particularly if the prices paid are above market (whatever that is!). The scale of this pollution is such that the sum total of government guarantees and obligations may impact the value the rest of the world puts on the U.S. dollar, the linchpin of the global financial system. In the end then, money and credit do turn out to have some something in common: the value of either depends entirely on the trust of strangers.

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Short Take

Relaxing COVID-19 Restrictions will Kill, not Save, the Economy


 

[This is a more developed version of the previous Short Take}

Those who want to relax mandates on self-isolation and social distancing to save the economy have got it exactly backwards. Reopen society too soon, and we risk destroying the economy as well as public order and our shaky democratic institutions. The reason comes down to two words: supply lines.

 Supply lines for necessities such as food are already under stress. Those going to grocery stories encounter random instances of empty shelves and vegetable bins. Smithfield Farms shut down a South Dakota plant that supplies roughly 4% of the pork in the nation after over 500 of its workers tested positive for the coronavirus. Other giant meat processors such as Tyson have also shut down plants for similar reasons. Farmers in the West are having trouble finding workers to harvest the crops now reaching maturity in the fields. And even if they manage to get the crops picked, farmers are out of luck if the truckers fail to show up, or the flow of packaging for their products get interrupted. 

Right now, these disruptions are episodic, but that should be concerning because we haven’t even seen the end of the first wave. What we have seen is that vital front-line workers such as nurses, doctors, EMT’s, and other first responders have had trouble finding protective equipment and maintaining morale. Some have staged walkouts over the dangerous conditions, and these are workers with a sense of mission.

By contrast, for most of the hourly-paid workers who keep supplies made, distributed, and sold, their work is a job that pays the bills. It would be appropriate if society recognized that they played a vital role, but mostly these workers encounter demanding bosses, monotony, and surly customers. If sick, they are not going to work – nor would we want them too. And they are not likely to risk their lives if going to work exposes them to contagion.

Disruption of one link, e.g. the trucker that delivers food the last mile, could halt a supply chain. COVID-19 is a threat to every link. Should a second wave hit before there is a readily available, cheap and effective treatment, it’s a very high probability that many supply lines will be disrupted and filling the gaps could easily overwhelm the nation’s businesses. 

Even today, on the evening news, we see images of vast caravans of cars lined up to get supplies from food banks. Imagine two weeks of empty shelves in the stores that feed our cities. How likely is it that civil order could be maintained in that situation? Will people suffer in silence if they realize that they can’t buy food for their kids because our leaders reopened the economy before a treatment was available because they wanted to prop up the stock market (which is how it will be portrayed)? If we want to look analogues for what life is like once supply chains break down, they’re readily available today in cities like Mogadishu, Kinshasa, and Port au Prince. 

 Thus far, the Trump administration’s response to the pandemic seems to be a mélange of Boss Tweed, Don Corleone and Inspector Clouseau. For the next act, the administration has a choice: Churchill, who bolstered British morale during the London Blitz, or Pol Pot, who sacrificed millions of his countrymen for a bad idea. Let’s hope those around Trump can convince him that the cure for the disease is the cure for the economy.
 



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