The other day a visitor from Washington asked what I was worried about. Give me some suggestions, I replied. Start with the banks. Are you worried about them?
Not anymore, I answered. There are plenty of Fed and US Treasury programs in place funneling liquidity and capital into banks. They add up to many hundred billions of dollars. More banks may fail, but on nowhere near the scale of the 1980s and early 1990s. The banking system as a whole is not at risk anymore.
But do I worry about subprime mortgages and mortgage-backed securities based on them? A little, I replied. Relatively straightforward ways of dealing with the problem were ignored or rejected. The Paulson "TARP" gambit had to be abandoned, because banks had no intention of selling troubled assets at fire-sale market prices but the Treasury couldn't get away with subsidizing banks by stealth and without conditions by paying well above market price. Toxic collateralized debt obligations, CDOs, are now under pressure again in the markets.
But there are still some promising options left. One is to use emergency powers to replace some defaulted mortgages with government-guaranteed ones. That will help hold down foreclosures. Another option is to fund state and local government purchases of foreclosed properties to keep them from being vandalized and ruining whole neighborhoods. Both provide time for restoring confidence that CDOs can recover.
But my visitor insisted that I must be worried about something. You're right, I answered. It's the stock market: I'm very worried about stock markets globally.