Dependency and the Financial Markets

Floyd Norris had an excellent post up yesterday concerning CIT and the financial system. I’d like to talk quickly about one of the points he makes.

Here is what he has to say:

Despite the slight opening of financial markets since the winter panic eased, this country does not have a decently functioning financial system. It is the Federal Reserve and the Treasury that decide which financial companies stay in business, which is something you expect from a centrally planned socialist economy, not from the great bastion of the free enterprise system.

Many of the better-off banks were able to repay the TARP money to the government, but they remain dependent on F.D.I.C.-guaranteed loans. CIT would be O.K., at least in the short term, if it could get such loans.

There has been a lot of hand-wringing over the failure of the Obama stimulus plan to get the economy moving, but where attention is really needed is the failure to get the financial system going. That was never going to be easy, but the worst possible decision was to allow the banks to fudge their financial statements. The Obama administration did not lift a finger to prevent Congress from demanding such a move, which the Financial Accounting Standards Board made under duress.

It is not easy to be sure how much difference that made in financial statements, although it clearly allowed some banks to pretend their losses were less than they really were — at least as measured by market values. The banks claim those market values are ridiculously low, but they will not divulge exactly what assets they own, or where they value them.

We are back to a situation where no one knows which balance sheet can be trusted. In that climate, the easiest decision is to trust no one — or at least no one without a credit line backed by Uncle Sam. Citi is too important to fail, but CIT may not be.

Remember General Growth Properties, the real estate mall owner that filed for Chapter ll earlier this year? They own some of the best retail space in the world. Their demise was not caused by an inability to meet their monthly interest obligations, it was caused by the inability of the financial system to accommodate their need to roll over debt. Debt that they could have easily serviced.

Now CIT finds itself in the same hole. It isn’t so much a question of CIT’s ability to service its existing debt or the new debt it needs to replace it as it is a question of its standing among the financial companies in the country. Is it or is it not a GSE is the real question.

There is only a pretense right now that the financial markets are functioning. Risk is measured by the prospect of how much government protection you may be able to muster not by the strength of your balance sheet or the certainty of your revenues. The only acceptable risks are sovereign risks and the rest will find no home.

Government guarantees have become the drug upon which the credit markets rely to maintain life. It’s one of the most addictive of elixirs. Weaning the markets from it will be very difficult and the more often it is administered, the more habit forming it becomes. Like any other dependency, recovery only occurs when the drug is taken away completely. Cold turkey is a traumatic experience which sooner or later we will have to employ.

About Tom Lindmark 401 Articles

I’m not sure that credentials mean much when it comes to writing about things but people seem to want to see them, so briefly here are mine. I have an undergraduate degree in economics from an undistinguished Midwestern university and masters in international business from an equally undistinguished Southwestern University. I spent a number of years working for large banks lending to lots of different industries. For the past few years, I’ve been engaged in real estate finance – primarily for commercial projects. Like a lot of other finance guys, I’m looking for a job at this point in time.

Given all of that, I suggest that you take what I write with the appropriate grain of salt. I try and figure out what’s behind the news but suspect that I’m often delusional. Nevertheless, I keep throwing things out there and occasionally it sticks. I do read the comments that readers leave and to the extent I can reply to them. I also reply to all emails so feel free to contact me if you want to discuss something at more length. Oh, I also have a very thick skin, so if you disagree feel free to say so.

Enjoy what I write and let me know when I’m off base – I probably won’t agree with you but don’t be shy.

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