The Global Economic Crisis evolved as a worldwide phenomenon, as major banks and financial institutions in virtually every significant economy became infected by toxic assets exported by the securitization engineers on Wall Street. Last October, the United States with its TARP, followed by major European countries including the UK, Germany and France injected previously unheard-of sums of borrowed money into their banks. This panic-driven injection of liquidity was sparked by the impending collapse of the global credit system.
Treasury departments and central banks far and near assured their publics that this speedy borrowing spree by the decision-makers had rescued the world’s financial system, thus serving the interests of the now heavily-leveraged taxpayer. Now, only three months later, it is clear that at a terrible financial cost, at most a short respite was purchased. The temporary lull in the LIBOR rate cannot, however, camouflage the essential truth; the major banks and financial institutions in many major economies, particularly in the United States and United Kingdom, are for all practical purposes insolvent.
A banking system that is insolvent is dysfunctional in the extreme. That is the core of the credit crunch that has now precipitated a Global Economic Crisis so egregiously destructive, it will likely exceed the Great Depression of the 1930s in its impact. This is why all the costly deficit spending on economic stimulus packages being enacted in the G7, BRIC and eurozone countries are doomed to failure. The key decision makers are aware of this conundrum, which is why they are frantically searching for a solution to the banking disaster that has frozen normal credit flows throughout the global economy.
The new U.S. Treasury Secretary, Timothy Geithner, postponed his speech on how the Obama administration intended to resolve the banking and credit crisis by 24 hours. Whatever solution he ultimately proposes it will probably, like TARP before it, be insufficient and require further interventions by the Treasury Department and the U.S. taxpayer. Indeed, dark clouds are obscuring an horrific reality; the American banking sector is insolvent to such an immense degree, it would in all likelihood require recapitalization at a level counted not in hundreds of billions, but rather trillions of dollars.
The paradox is that the U.S. economy, as with any other, cannot function without a solvent banking sector. At the same time, it cannot afford the cost of salvaging its banks. Consider what Professor Nouriel Roubini said in a recent interview with the Financial Times: “In many countries the banks may be too big to fail but also too big to save, as the fiscal/financial resources of the sovereign may not be large enough to rescue such large insolvencies in the financial system.”
Thus, the United States created a banking system with large institutions that are too big to fail, due to the systemic risk such a collapse would impose on the national and even global economy. It compounded this roll of the dice by removing any coherent regulatory regimes, instead trusting in the “self-correcting” character of the unregulated marketplace, which encouraged risky behaviors, otherwise known as “innovation,” leading to the creation of unsustainable asset bubbles.
Geithner may try to sugar-coat what in effect will be a TARP II, knowing that the public and its congressional representatives will be reluctant to mortgage the financial future of their children for the sake of another bank bailout. However, no matter how the Obama administration packages its own TARP II bank rescue effort, it is increasingly likely that the foreign credit markets the United States relies on for financing its grandiose deficit spending will simply lack the capacity to loan all the money needed to recapitalize America’s banks.
In the event the credit markets are unable to finance the rescue of the U.S. banking sector, then the lender of last resort will undoubtedly be the Federal Reserve. By resorting to quantitative easing, the Fed may purchase Treasury bills with bank notes it simply generates off of its printing press. In essence this is legal counterfeiting, conjuring up fiat money out of thin air. It may lead to the recapitalization of the banks, on paper. But the net cost will be the destruction of the U.S. dollar as the world’s reserve currency, along with the displacement of the current trend of deflation with a virulent and potentially uncontrollable outbreak of hyperinflation.
The bank rescue mission the U.S. Treasury Department and the Fed are currently embarked upon reminds me of what a U.S. Army spokesman once told journalists during the Vietnam War: “We had to destroy the village in order to save it.”
I fear that this same reasoning may be at work among the policy-makers in Washington, through the enactment of decisions that will destroy what remains of the U.S. economy in order to bailout the “too big to fail banks.” In this instance, however, it is not a village, but the whole global economy that hangs precariously in the balance.