Bernanke, Paulson, Obama & the US Economy

What's really wrong with the US economy?

A country gets into an asset bubble when it's economy is suffering a structural problem - the structure of its industries are wrong with respect to global demand and/or with respect to its competition. This can happen when the industries do not get the right signals from the market as a result of policy interventions which prop up those industries and which do not allow those industries to die a natural death. These structural problems could also be the result of the persistent use of pump-priming measures. Even persistent loose monetary policies may not be able to help as these industries are unable to use cheap capital and expand their way out of their inability to compete. Because inefficiencies and irrelevance have been allowed to continued for a long time, the only way the errors in policy will show is when the whole system fails and collapses.

With structural problems, throwing money at the problem will increase the aggregate demand in terms of both consumption and investment, but without the necessary the commensurate increase in production such that more and more money is flooding the economy. If sustained, a bubble is built up.

The original US$700 billion Troubled Asset Relief Programme was supposed to remove the toxic assets from banks. Let us say, the banks' NPL (non-performing loans) ratio is 30%, consisting of US$1000 billion bad loans out of a total loan portfolio of US$3000. If the US$700 billion is used to buy up the bad loans, the NPL ratio falls to 13%, as the bad loans fall to US$300 billion but the total loans now fall to US$2300 billion as the assets are removed from the banks (and not to 10% as of US$300 billion over US$3000 billion).

Paulson was said to have used half the US$700 billion to add capital into the banks. The one half (US$305 billion) will be used to remove the bad loans and this will reduce the NPL ratio to 23.6% (US$650 over US$2750). The banks still have to make provisions for the remaining bad loans of US$350 billion - will be competely chew up the injection of new capital a la Paulson. The banks still remain without liquidity and the NPL ratio is higher (at 23.6%, rather than 13% in our example above).

The Obama proposed US$800 billion fiscal stimulus plan which, as I can gather, is about new spending and tax cuts. This will put money into the system and help some businesses. But I agree with Bernanke that this will not help the banks. In any case, the Obama plan was more a supplement on the assumption that the US$700 billion TAR Programme is sufficient.

My view is that Paulson may have weakened the initial US$700 billion plan to provide leverage for the banks to lend by his hasty investment plan for the banks. Bernanke is basically saying in a roundabout way that Obama will still have to revisit the banks because of the Paulson intervention.

I don't see the remark to show the sign of a possible split between the Fed and the White House. Bernanke is just being realistic.

Whether the plans will work or not to get the US economy moving again is, unfortunately, another story.