Thursday, November 06, 2008

Cross-Talk: Stabilizing Debt Markets as a Priority for the New Obama Administration

A recent New York Times analysis includes economic stimulus, aid to the auto industry, and economic assistance to homeowners at the top of likely priorities to start the Obama presidency, followed by a regulatory crackdown on Wall St. Indeed, the President-Elect has suggested that the tax relief promised during the campaign will be the first bill that he introduces when he comes to office.

In his latest post, which I heartily recommend reading, Jeff Miller proposes a very different priority for the new administration: stabilize trading in debt securities. That requires a process of price discovery that will enable banks to objectively assess their vulnerability--and that of others--so that they can once again function as trusted participants in financial markets.

"Counterparty risk" is a top-of-the-mind concern for many banks and hedge funds. Concerns over preservation of capital have led them to withdraw from many credit markets. When hedge funds and investment banks are mentioned in normal political discourse, however, the focus is usually on how to punish them and hold them accountable for their greed--not on how to restore their proper functions to the marketplace.

There is no question that laws and regulations must be enforced and that proper regulation and oversight of markets must be ensured. The priority is not to "bail out" banks, but to ensure that markets function normally so that lending can proceed and reinvigorate housing, business, and the general economy.

While it's nice that interbank lending rates have declined from their historic peaks, it is far from clear that financial institutions have the trust and confidence to use the cash from the government to resume their normal lending functions. Banks are not lending when borrowers can obtain funds from the Fed cheaper than they can in the normal market; banks are also not lending when vulnerable businesses, consumers, and homeowners look to become more vulnerable. But if banks and other financial institutions additionally won't do business with each other, then we have markets in dislocation and unable to facilitate an economic rebound.

Thus far, if press reports are accurate, Jeff Miller's suggested priority for the new administration does not appear to be on the radar. Hopefully, his efforts and those of others will correct this situation.