Yesterday, the folks at Baseline Scenario offered a post-G-20 assessment of our economic situation. If you're familiar with the thinking of Simon Johnson and his cohorts, you won't be surprised by their conclusions, but as as a comprehensive round-up it's well worth reading:
On balance, we believe that the Obama administration, and Fed Chairman Bernanke, are making every effort to combat the financial and economic crisis. However, some aspects of the response, most notably the fiscal stimulus, have been underpowered. And a combination of ideological and political constraints has hampered the administration's efforts to rescue the banking system. For these reasons, we still do not see the mechanism that will cause the economy to turn around.
In this context, we interpret the recent stock market rally as indicating that the economic decline is slowing; it does not necessarily denote that rapid recovery is just around the corner. We would also emphasize that credit markets are pricing in a substantial risk of default for some leading brand names, both in financial services and manufacturing -- as the system stabilizes and bailouts become harder to justify, the probability of default for large companies may continue to rise.
Unsurprisingly, they are most critical of the response to the crisis in the financial system, and while their arguments about the credibility of the stress tests in and of themselves are persuasive, I think this sentence gets at the crux of the difference of opinions between the administration and its critics: "It is possible that the stress tests will be used to force banks to sell assets as part of the PPIP, which would be a good but unexpected consequence." But Treasury has made clear that it sees the capital injections program (which the stress tests are attempting to quantify) and the PPIP as part of a larger mechanism. Thus, using stress tests to force major banks to off-load troubled assets (or using PPIP as a more targeted way to identify insolvent banks) are both "good" -- in the moving toward more aggressive policy sense -- and likely expected, at least among Treasury staffers.
-- Tim Fernholz
