Tuesday, May 5, 2009

U.S. Bank Recovery Isn't Credible, Richardson and Roubini Say

By Alan Purkiss

May 5 (Bloomberg) -- The results of the U.S. government's stress tests on the banks will be taken as showing that the worst of the financial crisis is past, but the reality is quite different, said Nouriel Roubini amnd Matthew Richardson, both economists at New York University.

Writing in the Wall Street Journal, they said the International Monetary Fund puts losses on U.S. loans and securities at $2.7 trillion, double its estimate of six months ago, and the calculations of RGE Monitor, the consulting firm of which Roubini is chairman, point to a total of $3.6 trillion, indicating that the financial system is close to insolvency on aggregate.

This means ``bailout purgatory'' is back, they said, before listing some suggestions for getting out of it.

First, Treasury Secretary Timothy Geithner's program of financial-asset purchases shouldn't be given up, for it promotes price discovery and does the job of removing toxic assets from the banks' balance sheets.

Second, Roubini and Richardson argued, the government should stop providing no-strings capital and loan guarantees and impose covenants restricting asset-use, risk-taking behavior and future indebtedness.

Third, they said, given the likelihood that some of the banks will be insolvent, the government must devise a plan for dealing with them that doesn't involve unlimited amounts of taxpayers' money; that means it will have to manage the systemic danger resulting from these institutions' failure while transferring risk from taxpayers to creditors.

Congress should quickly pass an ``insolvency regime law'' giving the government authority to handle complex financial institutions in receivership, as it's been requested to do, Roubini and Richardson said.

The administration should hold out such a law as an incentive for creditors to cooperate in a debt-for-equity swap; while this will result in a ``$1 trillion game of chicken,'' it's the best way forward, otherwise taxpayers will just go on paying, the economists concluded.

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