Baltimore City Paper

Putting Two and Two Together

In recent weeks the stock market has rallied--it's up another fraction of a percent today--despite what would appear to be some sobering realities. Chrysler declared bankruptcy yesterday (President Obama says the multi-billion dollar company will go through this quickly; has he ever even read a bankruptcy filing? Even the puny little million-dollar cases I've reviewed take a couple years). Meanwhile, banks are bracing for (and apparently fighting) the results of a stress test the government has reportedly run.

I've not said anything about the stress tests, in part because I, like everyone else commenting about them, don't know what the tests actually are. The government says they're checking the 19 biggest banks to see if they're solvent and to make sure they raise more capital if they aren't. Commentary has ranged from "the fix is in" (read: that is, the government won't let anyone important like, say, CitiGroup, fail the test) to "the tests are killing the banks" (read: so the government has pushed back the public release of the results from April to May, and now from May 1 to next Thursday). No one who is paying attention thinks these stress tests will show citizens anything real.

The thing I keep coming back to with this issue is the apparent confusion--and I think that among the political bosses it's deliberate--between a liquidity problem and a solvency problem.

A "liquidity crisis" occurs when you get to the cash register after eating a nice meal out and notice, for the first time, the sign that says no credit cards accepted. If you've got only $22 in your wallet and your tab is $63.80, that's a liquidity crisis.

A solvency crisis is something else. If liquidity means you don't have $63.80 in your wallet, insolvency means your credit cards are already maxed out and you don't have $63.80 in the bank. Because "credit has dried up," the government has been claiming this financial crisis is a crisis of liquidity. The stress test is supposedly discovering whether our financial institutions have $63.80 in cash or real assets.

In many cases, it is far from certain that they do, and I've explained as best I can in broad strokes of why this is, from the trouble with "Level 3" assets, to the issues involving their disposal. But the details underlying bank regulation can be really complicated, and I'm no expert on any of it. So I'm left kind of speechless when I come across something such as this announcement regarding Changes to the Discount Window & Payment System Risk Collateral Margins Table.

This document has the look of a pretty big change. It appears to say that banks were told that, beginning April 27, the loan-to-value ratio on the assets they pledged as collateral to the federal government changed, and for the worse. Friday, one week ago, they could borrow from the fed 85 percent of the stated value of the home equity loans they had made. On Monday, 50 percent.

Stress test, anyone?

I don't understand enough bank regulator-speak to really know what this thing is saying. It just looks bad, and all the reporting I've come across on the banking crisis and the stress tests have failed to mention this one little data point. That might mean it's not important. It might mean that I'm ignorant and missed the big story. Or it might mean--and with the state of journalism these days, I have to think this possibility is real--that it actually is a big deal, but that the press missed it.

At times like this I miss the late Tanta--aka Doris Dungey--who used to post pointedly detailed and knowledgeable minutia about banking on the Calculated Risk blog. Tanta would explain what this stuff means.

Now, I'm not saying it would do any good. Looking back two years at a short Tanta post and some of the responses sums up what I think is a deeper problem ailing our nation's response to the financial crisis:

Being right and reasonable in the spring of 2007--this is a year after the mess began to unwind and even people without eyesight or insight could feel it--drew comments such as this one to Tanta's explanation of MBS credit enhancement:

What's so fascinating about this is not that it happens. Trolls and assholes are a fact of life in the blogosphere. What's fascinating is that this kind of thing dominated the anti-Tanta commentary on her threads. There were very few thoughtful people who weighed in with actual data or insight into how the market or the particular "financial product" Tanta had just explained actually worked. It was always, "you're a permabear" or "you're selling fear" and "no one can verify what you say or even understand it."


But no one tried to understand. It was stupidity revealing itself. And what I found so interesting on these posts--as I have during a 20-year career in journalism--is how easily so many of the stupid, fueled by a bit of capital and a lot of optimism, got pretty rich just by following the herd. For them, until recently, it was a Faith that Works. And the bailout is designed and meant to save their religion from the market's deeper reality--at least for now.

The irony, of course, is this: if the bailout plans do ameliorate the financial crash, the morons like "PlayMeSomeDoom,Sam" will gloat that they were right all along--that people such as Nouriel Rubini and Tanta and Paul Krugman and the myriad other smart people who saw this thing coming were wrong to worry and warn, and so the cycle of idiocy-begeting-crisis-begetting-bailout will continue in this self-reinforcing loop, with the ignorant, the stupid, and the over-optimistic getting richer while the knowledgeable, the intelligent, and the cautious get the shaft.


We'll need a very different kind of stress test to stop that cycle, and one day we shall get just that.