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Friday: Tunnel Vision

Just when you thought it couldn’t get any worse with the banking system, we have a *new* concept to grapple with and this one should make you want to sharpen your pitchfork.  It’s called “tunneling”.  In short, tunneling occurs when bankers on the brink of insolvency are kept afloat just long enough for them to hide the good assets while they leave the bad assets for the government to absorb at taxpayer expense.  Isn’t that fun?  You can read all about it at NakedCapitalism.  And our administration’s resident genius, Tim Geithner, has set up conditions in a way that seem to be perfect for just this sort of thing.

Simon Johnson of Baseline Scenario explains what is going on:

Emerging market crises are marked by an increase in tunneling – i.e., borderline legal/illegal smuggling of value out of businesses…

Boris Fyodorov, the late Russian Minister of Finance who struggled for many years against corruption and the abuse of authority, could be blunt. Confusion helps the powerful, he argued. When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

Treasury has made it clear that they will proceed with a “mix-and-match” strategy, as advertized. And people close to the Administration tell me things along the lines of ”it will be messy” and “there is no alternative.” The people involved are convinced – and hold this almost as an unshakeable ideology – that this is the only way to bring private capital into banks.

This attempt to protect shareholders and insiders in large banks is misguided. Not only have these shareholders already been almost completely wiped out by the actions and inactions of the executives and boards in these banks (why haven’t these boards resigned?), but the government’s policy is creating toxic financial institutions that no one wants to touch either with equity investments or – increasingly – further credit.

Policy confusion is rampant. Did the government effectively sort-of nationalize Citigroup last Thursday when it said Vikram Pandit will stay on as CEO? If that wasn’t a nationalization moment (i.e., an assertion that the government is now the dominant shareholder), what legal authority does the Treasury have to decide who is and is not running a private company?

Will debtholders be forced to take losses and, if so, how much and for whom? As part of last week’s Citigroup deal, preferred shareholders – whose claims had debt-like characteristics – were pressed into converting to common stock. You may or may not like forced debt-for-equity swaps, but be aware of what the prospect of these will do to the credit market. Junior subordinated Citigroup debt (securities underlying enhanced trust preferred shares) were yesterday yielding 26%….

What do rapidly widening credit default spreads for nonbank financial entities (such as GE Capital and many insurance companies) signify? Is it something about expected behavior by the insiders or by government, or by some combination of both?

Confusion in policy breeds disorder in companies, and disorder leads to the loss of value. This is the reality of severe crises wherever they unfold; we have not yet reached the worst moment. And, of course, there are many more shocks heading our way – mostly from Europe, but also potentially from Asia.

The course of policy is set. For at least the next 18 months, we know what to expect on the banking front. Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches (I’ve asked). The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails.

Read it and weep, Obots.  This is what you worked for.  Obama is in bed with these people.  They helped him buy off superdelegates and pay for massive amounts of advertising.  They helped him trash the reputation and career of a much better candidate.  They footed the bill for those stupid Greek Columns.   Our retirements are in jeopardy right now and the bankers are using the confusion to loot whatever’s left and stash the booty in an underground banking system.  It’s the finance version of the Shock Doctrine.  Before you know it, there won’t be anything of value left.

Paul Krugman is also alarmed by the “dithering” that is leading to more confusion and the possibility of acts of bad faith among bankers.  When Krugman starts to worry about the deficit, you know the situation has gotten out of control.  The administration keeps throwing money at the problem, hoping to kick start it to life.  But the administration seems to be adamant about protecting the bankers from taking their medicine:

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they’re needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don’t need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it’s just not going to happen.

So why has this zombie idea — it keeps being killed, but it keeps coming back — taken such a powerful grip? The answer, I fear, is that officials still aren’t willing to face the facts. They don’t want to face up to the dire state of major financial institutions because it’s very hard to rescue an essentially insolvent bank without, at least temporarily, taking it over. And temporary nationalization is still, apparently, considered unthinkable.

But this refusal to face the facts means, in practice, an absence of action. And I share the president’s fears: inaction could result in an economy that sputters along, not for months or years, but for a decade or more.

Um, I don’t think I can wait a decade or more to see *if* my 401K investments bounce back.  I want to see things returning to some kind of normal state pretty damn quick so I know that recovery is possible.  Now, I’m no financial wiz but I think we’ve all seen something like this happen before. Your computer starts to hiccup.  At first, it’s just a minor thing and you ignore it.  Then it happens again and again with greater frequency.  Before you know it, you’re opening and closing windows, relaunching programs and tinkering under the hood with network settings.  The last thing you try that you know you don’t want to have to do (because you’re not sure everything is saved) is a reboot.

It’s time to hit that power off switch.