Obama must fight the disease, not the symptoms: Gottliebsen

The Obama Presidency, with its wonderful rhetoric, gave world markets an expectation that we could minimise the fallout from the global financial crisis. The markets knew that there were vast sums on the sidelines waiting to snap up the toxic bank assets and begin the recapitalisation process. In other words; this was a problem that could be solved. The sharemarket believed – or more accurately hoped – that Obama was the man to do it.

But on the first hurdle he stumbled, and in coming months unless he can pick himself up, his future rhetoric will sound hollow.

Obama’s mistake was to fail to understand that his so-called rescue package, which went to the Senate, was mostly about relieving symptoms. That’s also what a big section of the Rudd rescue package is about.

In the case of the US (not Australia), this is a crisis caused by a banking system failure. Not until you cure the cause of the disease can you go forward. Relieving symptoms is important, but the disease will keep attacking you unless you find a way to cure it.

As I have been writing, the global banks have losses of about $US2.2 trillion, but have only recognised and funded $US1 trillion.

Treasury Secretary Geithner is talking about a $US1 trillion fund – he looks to be $US1.2 trillion short, but maybe when the detail emerges that will be wrong.

As Alan Kohler revealed yesterday, many of the concealed or unrecognised losses are in synthetic CDOs. These instruments are so complex that the US treasury is not finding it easy to rescue the banks from the mess they have created.

It’s extremely difficult to rescue someone from losses they have not revealed to their shareholders.

What we may require is a clean sweep, whereby the whole synthetic CDO mess is unravelled and the losses realised. Then we go around fixing the damage.

The alternative is to enable banks and the system to repair itself over time so the CDOs don’t explode. That’s a long process, but it looks like we may be heading down that path via massive attacks on the symptoms.

I will use a nasty analogy. Cancer patients normally die unless a way is found to stop the disease. Their pain can be relieved with morphine, but if the disease remains uncured the morphine can become the killing agent. Too much money wasted in deficit spending attacking symptoms will create its own problem.

The tragedy is that there are vast sums in so-called vulture funds out there looking for the bottom ready to buy the toxic assets because they believe there is an opportunity. Wall Street’s big fall indicates that the market now fears they will not come in until all the losses are on the table and the vultures know what the risks are. Over time attitudes can change, but that’s how it now stands.

Part of the Obama Administration’s package involves forcing banks to loan money on houses etc. That’s a fine thing to do but, like the big spending package, it is attacking the symptoms.

Yesterday’s fall on Wall Street does not take it down to last year’s low point, so it may recover. It’s a warning sign, not a death sentence. Obama may learn from his mistakes and indeed pick himself up. Remember he is on the right track because the market is able to solve this problem by investing in the toxic assets, but only when they know that all the losses are on the table.

The underlying problem is that the US political system may not able to solve the problem until the Congress is confronted with the full horror of the concealed losses when they are revealed.

A lot of Australian charities and local councils last night took a step towards bankruptcy as a result of the losses they may sustain on synthetic CDOs. At some point – probably now – they need to do what the US banks have refused to do and recognise the looming loss.

This article first appeared on Business Spectator