Friday, January 22, 2010

Obama vs 'Evil Banks', But Who Buys His Government's Debt?

Treasury Secretary Tim Geithner seems to have doubts about the latest bank regulation proposal by his boss. Other lawmakers are cautious in commenting on the proposal to ban proprietary trading and investing in hedge funds.

Aside from the questions like "Does proprietary trading matter?" (or for many lawmakers, "What is proprietary trading?") and "Did it cause the market turmoil and crash in 2008?", I'm thinking about the consequences of openly declaring "war" on the nation's banks, fake or not.

One of them that occurred to me is this: Who is going to buy all the debt that the president and his administration is going to incur?

The nation's big banks happen to be the primary dealers of the Federal Reserve, who are required to bid at the Treasury auctions. Goldman Sachs, J.P.Morgan Chase, Morgan Stanley, Citigroup, Bank of America all bid in every single Treasury auction. Every week, Treasury Department sells short-maturity bills to the tune of $50 billion or more. Longer-maturity notes and bonds are sold every other week, often exceeding $100 billion.

Would the administration risk totally pissing off these banks who buy and arrange others to buy the government debt that is set to increase even bigger? The administration needs to fund $1 trillion-plus deficit, plus $1.5 trillion debt rollover.

The answer is rather obvious.

The president is striking a populist image of fighting the 'evil banksters' by focusing on the secondary or tertiary issues that need to be addressed in a real financial reform but which probably didn't cause the market melt-down in 2008. Is he talking about regulating OTC derivatives like CDS? Is he talking about rating agencies? Is he talking about securitization of illiquid and potentially risky assets like mortgages and credit card debts? No, he isn't.

Instead, he focuses on what the average Americans can understand - big bonuses.

The stock market is tanking for the third straight day. Since Wednesday, Dow Jones Industrial Average has lost over 500 points, or 4.6%. A panic will break out if Dow dips back below 10,000 again, which is only 200 points or so away, as it may feel like the nightmarish days of October 2008 are returning.

On October 2, 2008, Dow started the plunge after the bank bailout bill passed. In three trading days, it lost 870 points. In seven trading days, it lost 2,375 points, or 22%.


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