Wednesday, February 18, 2009

Eisinger and Salmon on the financial crisis

Jesse Eisinger (Portfolio) and Felix Salmon talk about the financial crisis and the government response.

It's worth checking out if only because it's nice to hear a relatively optimistic viewpoint from someone (Salmon) who is more interesting than the usual permabulls on CNBC. At the same time, I agree with Eisinger that Salmon is totally underestimating the trouble that the banks are in, by overestimating the extent to which debt is being temporarily "mispriced" because of liquidity constraints. As Eisinger says here:

Eisinger also makes a point I've been meaning to make about the relationship between government policy and the stock market: Bank nationalization could be (and I think probably is) the best route to take for the country, economically. But that doesn't mean it wouldn't have dire implications for financial stocks. A lot of them would go to zero! And that's what should happen because they are at the very bottom of the capital structure (i.e. last in line to get their money back) and there's not enough money to go around. Even debtholders, who are ahead of them in line, will probably lose some of their investment.

Even though most of the damage has already been done (bonus Salmon link), bank nationalization would almost certainly result in "another leg down" in the equity markets. Just mechanically, with index funds and ETFs, you can't literally wipe out a lot of shareholders in one industry without affecting shareholders in a bunch of other industries. It would almost certainly be Bad For Stocks.

But the real economy would survive bank nationalization just fine. Individuals and businesses would still go to the same bank, it would just be owned by the government instead of a bunch of really pissed-off stockholders.

Anyway my guess is Obama really doesn't want to go the "Swedish route" but people should realize that the stock market should absolutely be expected to react poorly to bank nationalization (or an increasing perceived probability of it), and that the declines are in no way evidence that nationalization is a bad idea.

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