Asset Bubbles, Cheap Money, and Leverage

Ami sent me an article about how the big banks are not re-loaning their TARP money to those in need. This doesn't surprise me, and it means the TARP money isn't expensive enough.

The whole idea of a capital injection is that it puts tax payers and banks on the same side. If we just buy toxic assets, banks that survive make a profit while we (taxpayers) have junk on our hands. If we buy equity in the bank and they are profitable, we get our money back and then some.

But our goal as tax payers is not to be speculators in distressed financial stock - it is to keep the banking system from melting down. So if a bank has enough money to go on a shopping spree with TARP, the "cost" of that equity isn't high enough. TARP bail-out money needs to be painful enough to existing equity holders that they'll use as little of it as they can.

I've done plenty of ranting about the various fire drills we've been through during the bail-out, but what about the bigger picture? Here's a thought: a return to "healthy" lending levels may not be healthy at all if our previous lending levels were way too high.

Right now the Fed is thinking about whether to further cut interest rates. Ignoring the important question of whether further rate cuts will do any useful short term good, I would suggest that too much capital isn't a useful thing. I am a fan of Mark Cuban's blog, and he says it better than I can in this post.

Cheap money means lower risk premiums, higher leverage, and it makes all sorts of great things possible:

• Leveraged Buy-Outs. (Is this really useful? Ask the employees of Linens N' Things.)
• High Leverage Ratios. (Worked well for Bear Sterns. Heck, it worked great for LTCM!)
• The Carry Trade.

At some point cheap capital doesn't cause us to work more efficiently, it causes us to spend more time playing games with cheap capital.

We've had an internet bubble, a housing bubble...is the way out of the mess really to lay the groundwork of another bubble?