Quick rant…..
Admit it, we don’t really care if a bank or financial institution fails. What we care about is unemployment and economic growth. The two things are connected when a bank failure causes a credit collapse (ala Lehman…although that simply accelerated and extentuated a crisis). Thus was it right to simply stress test the banks? I want to make the point that it is part but not the whole picture. Stress testing the banks is a good idea (hard to tell how well it was done). A regulatory menatility of probabilistic thinking is the right one.
That being said it is not enough…the Federal Reserve as the monetary authority should be concerned with aggregate credit creation (as that is what is driving the deflation). The driving force behind the credit contraction is financial market deleveraging. This is occuring both in the banking sector and the non-bank financial sector. To put it simply the banks need to be absorb the delevering of the non-bank financial sector (or the fed has to do it…which it has done to a large degree) or a credit collapse will occur. What does this mean? We want the banks to have far more capital than they need to survive…like I said up top, we don’t simply care about bank survival.
I was hoping that the stress test would be the rhetoric device to get capital into the system but it doesn’t look like it worked that way (although it does look like banks are raising lots of capital to pay off TARP and if that TARP capital is sent back out into the banking system we might get closer to where we need to be). I keep coming back to the same idea (not good but the best I’ve got) drown the banking system in capital and don’t let them pay it back until the economy is back on track. Some argue that this would be expensive, yes but it is cheaper than everything else. It would be cheaper than a depression and it would be less dangerous (thus cheaper) than having the Federal Reserve doing all of the deleveraging.
