Backfire When Governments Give a Pep Talk

Let me relate a story to you that after the Crash of 1959, President Hoover called together a group of the nation’s business leaders for a special meeting in Washington, and his message went something like this:

“When you go back home tonight, you’re going to do the right thing for our country. You’re not going to lay off employees. You’re not going to stop hiring. You’re going to do everything in your power to keep the economy going”

Outcome:- they did precisely the opposite, taking major steps to cut jobs and the rest is history.

Since the credit crisis burst approximately 14 months ago, I note that each new government countermeasure seems to have backfired. Investors are shifting some assets back to weaker hands while banks’ balance sheet continuing to deteriorate. It creates greater divide between price and reality and as soon as symptoms of the true risk levels resurfaced, there will be sudden and explosive market adjustments. Either, one rushing to dump high risk assets, which the line gets blurred by days and other category of investors, who otherwise might have not been unduly impacted by this, also suffered parallel losses and surging anxiety.

In turn, the authorities may actually have exacerbated the very panic that they initially want to avoid. I believe this is because the US debt crisis is far larger than previously believed. As of 1Q08, 1,479 banks and 158 thrifts at risk with US$3.2 trillion in assets, or 41 times the bank assets estimated at risk by FDIC.

Today, at one hand, the authorities finding panacea for current financial illness, on the other hand, the authorities are risking their balance sheet and perhaps too soon for the debt markets. In the Fiscal Year 2009 mid-session review, the Office of Management and Budget projected the 2009 US federal deficit will rise to US$482 billion – hence a major burden on US and other debt markets (That commitment is made before the recent bailout commitments were known). If that amount is included into the equation, it can easily exceeded US$1 trillion mark and certainly this can be confidence damaging and if the situation is serious enough, it could be a global paralysis for short-term credit markets.

The end results can be very corrosive and could be a cause for more losses and pains, if many people are exiting the banking system.