Will It Work?

Daily Forex Fundamentals | Written by TheLFB-Forex.com | Sep 21 08 11:36 GMT |

Answer: Absolutely

Reason: It has been done successfully before. A very similar situation happened in Sweden in the early 1990's with the difference being that in the Swedish case, the situation was far worse.

Qualifiers: This doesn't mean stocks can only go up and it does not mean the U.S. cannot go into a recession. However, when you put today's losses in proper perspective with respect to Gross Domestic Product and reference a longer term perspective (3+ years), the Treasury's plan to set up a “bad bank” by purchasing distressed mortgage securities will absolutely work. Not only that, but if we have the foresight to follow what the Swedes did afterwards, perhaps we can see a recovery that will be swifter and possibly even avert a recession.

The Wall Street Journal had the foresight to publish an article written by Joellen Perry on April 7 which covered what happened in Sweden during their early 1990's real estate-driven banking crisis. The parallels are so eerily similar that after reading it I became infuriated that the U.S. was unable to learn from history and avert the present crisis entirely.

How familiar does this sound: A deregulation of credit markets fuels a real estate lending boom which is further enabled by low interest rates, lax supervision and poor lending standards. The result? A massive asset inflation (bubble) which sees real-estate values and stock prices more than double in a few short years. Once the bubble bursts and housing prices decline, the banks start totaling up the losses from all the loans they should never have made in the first place. Liquidity dries up. Unemployment rises and the economy is threatened by (and eventually goes into) a recession.

This was Sweden in the late 1980's and it was the U.S. from 2003 until now.

Mr. Paulson's plan offers basically the same solution as was applied in Sweden back in 1992. The Swedes set up so-called bad banks to manage the troubled real estate assets and by doing so allowed the banks to concentrate on their remaining sound businesses and engender their own recoveries. “It became clear that if we didn't do something quickly, the whole system could collapse. If it's just a few institutions, you can have an ad hoc solution, but when the whole system is in danger, you need a new framework." These are not the words of President Bush or Mr. Paulson, although each have recently expressed sentiments which sound exactly the same. They are the words of Göran Lind, a senior adviser to Sweden's central bank at the time of the crisis.

The steps taken back then allowed the Swedish economy, which first suffered through 12% unemployment and a real recession, to recover relatively quickly. By 1994 and 1995, Swedish GDP posted annual growth rates near 4%.

Some Further Comparisons

According to Ms. Perry's article, the total loan losses on Sweden's biggest banks to some 12% of the country's gross domestic product. A table published by Bloomberg on August 12 put total U.S. bank losses at $246.2 billion, just over 48% the IMF estimate of $510 billion in total global losses. In an economy which was over $11 trillion in 2007, that amounts to about 2.25% of GDP, far less than Sweden's' 12%. While bank losses have not been completely totaled, mitigating this is that fact that U.S. banks have raised a total of $163.2 billion in fresh capital. The IMF is currently estimating global losses to reach over $1 trillion.

Once the banks' troubled assets had been taken over, the Swedish government “required the banks to disclose expected losses immediately and it quickly assigned values to other assets, rather than let banks postpone reporting losses and take gradual write-downs. Banks receiving capital injections or loans surrendered shares to the government to avoid the possibility of rewarding shareholders, and to give Swedish taxpayers a chance to profit when the market improved,” according the WSJ article, and according to Mr. Lind, taxpayers did eventually make a profit once the economy recovered and the government found buyers.

One can only hope to see the U.S. take a lesson from history and enact similar measures now.

Currency and Equity Market Implications

Once the market comes to the realization that a solution has been enacted, the dollar will appreciate. While it is difficult to say exactly when that may occur, there will be a good chance to see this happen in October when the National Association of Realtors reports on September existing home sales and median price. As far as stocks are concerned while we wouldn't bother predicting what will happen in the very short term, if you are an investor with a longer term perspective you are likely being presented with an extraordinary buying opportunity at this time.

Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com

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