We need to restore confidence in the US financial institutions

Tonight, the President addressed the joint session of the Congress. Unlike the typical State of the Union addresses, the President spoke directly to the American people, trying to explain why the $800B stimulus spending is necessary when the private sector spending is right now in retreat, and why the government needs to do whatever it takes to shore up the nation's financial institutions, to get the credit flowing again.

I think the President was articulate and made a strong case. In contrast, the Republican response, delivered by Louisiana governor Bobby Jindal, was so poor that it sounded like a botched Saturday Night Live skit.

The old Republican argument that "the government is not the solution, but the problem" sounds so irrelevant these days. If the Republicans don't believe government can ever work, why do they seek to be elected to public offices? To prove that government indeed does not work? Yeah, we got plenty of proof in the Bush administration. Bush's cynical view about the role of government led to massive outsourcing of critical government functions to private contractors run by those who put him in office. The end results were terrible and deadly (in both Iraq war and Hurricane Katrina).

OK, I don't want to go back talking about Bush nightmare anymore. It is past. Now the critical task is how to restore investors' confidence in the US financial institutions.

There are concerted efforts to undermine the financial institutions. Some cried for "nationalization of the banks", while others screaming "No more bailouts. Let the banks fail".

Do US financial institutions have adequate capital? The answer is an emphatic yes. Then you ask what is the problem? The problem isn't banks having insufficient capital. The problem is investors' confidence. Majority of the financial institutions need access to the debt market for financing. In normal time, there are plenty investors willing to lend money to the banks. But this is not normal time. Investors have doubt in banks' balance sheet. I think these doubts were healthy. For a long time investors risk premium was too low. But now, there are those short sellers out there trying to create panic among the investors. They claim that "the entire US financial institutions have ZERO equity", without needing any facts to substantiate the claim. And they pay the debt rating agencies to downgrade credit ratings of the banks. They went on the TV, masquerading as libertarian capitalists speaking on behalf of regular people against government help bailing out "Wall Street thieves". But their ulterior motives are to instigate a run-on-bank of the US financial institutions, create a self-fulfilling prophecy of doom-and-gloom.

In my previous post, I have argued that the bad asset issue related to subprime lending is a tiny tinny problem. The big problem is that investors losing confidence and refuse to lend. That is why investors are piling cash into treasury securities, considered risk-free. In this circumstance, the Fed, and the Treasury have to step in to be the lender of last resort. That is what they are doing. And that is why I believe they should continue doing that, and communicate their determination to the public, so that confidence may gradually be restored.

Bernanke today did some of that during his testimonies in front of the Congress. I need more forceful pronouncement from the government more often and more clear.

I am hopeful that today's >4% rally in the stock market is the beginning of an end of the current financial crisis.