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A COUPLE ITEMS FROM LAST WEEKS NEWS

A COUPLE ITEMS FROM LAST WEEKS NEWS

Washington’s confusion and ineptitude in addressing the U.S. banking and economic problems has not given the markets comfort (more on that below).   The problem is complex, but there are people in the world who understand the economics and have ideas for addressing the problem.

Pete Peterson, the former Commerce Secretary and founder of Blackstone Group was interviewed in the Financial Times last week.  He offers the reader an excellent big picture view of how we got here, and what tough medicine is required.

The article can be found at: http://www.ft.com/cms/s/0/c659e57a-0202-11de-8199-000077b07658.html

ZOMBIE BANKS

Below is a short article in the Wall Street Journal that highlights the risk of not doing enough to recapitalize the banks and clean up their balance sheets of bad assets.  Half measures are likely to prolong the economic malaise as it postpones the eventual cleansing that is needed.

The Curse of the Zombie Banks
Wall Street Journal-February 26, 2009.

The Federal Reserve’s lending programs have saved the financial system’s life. They also could be making its life miserable.

That is one takeaway from a research paper by Douglas Diamond and Raghuram Rajan of the University of Chicago, published online this week by the National Bureau of Economic Research.

As fresh data from the Fed will show Thursday, the central bank’s balance sheet has more than doubled since August 2007. Some Fed programs have helped loosen the credit logjam, including the Term Securities Lending Facility, which lets banks borrow money using mortgage-backed securities and other hard-to-sell assets as collateral.

But the Fed also might have kept alive weak banks and other institutions having balance sheets stuffed with toxic assets, the two professors suggest. The weak are afraid to sell such assets because doing so would wipe them out, while strong institutions don’t want to buy because they are holding out for a fire sale.

Without a lifeline from the Fed, the weaklings could have died, putting the assets in stronger hands at cheaper prices.

"Central bank intervention to lend against all manner of collateral may not be an unmitigated blessing," Messrs. Diamond and Rajan wrote.

The consumer-loan-focused Term Asset-Backed Securities Loan Facility, which will roll out "very soon," Fed Chairman Ben Bernanke said Wednesday, could raise similar problems if consumer credit quality keeps withering.

Of course, doing nothing to help credit would have been catastrophic. But "zombie" banks are a reminder that clearing one logjam can make another one even worse.

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