Reality Used To Be A Friend Of Mine
Hard realities for the Obama Administration. The bailout didn't work. At least, it didn't work to save the nation's banks, whose value has dropped 43% in the last two weeks (this market capitalization chart of US banks is particularly vomit-inducing). It likely did work for who it was intended, and that's executives and shareholders.
Congress approved the $700 billion rescue plan with the idea that banks would help struggling borrowers and increase lending to stimulate the economy, and many lawmakers want to know how the first half of that money has been spent before approving the second half. But many banks that have received bailout money so far are reluctant to lend, worrying that if new loans go bad, they will be in worse shape if the economy deteriorates [...]
Individually, banks that received some of the first $350 billion from the Treasury’s Troubled Asset Relief Program, or TARP, have offered few public details about how they plan to spend the money, and they are not required to disclose what they do with it. But in conversations behind closed doors with investment analysts, some bankers have been candid about their intentions.
Most of the banks that received the money are far smaller than behemoths like Citigroup or Bank of America. A review of investor presentations and conference calls by executives of some two dozen banks around the country found that few cited lending as a priority. An overwhelming majority saw the bailout program as a no-strings-attached windfall that could be used to pay down debt, acquire other businesses or invest for the future.
They're just using the money to fill the black hole in their balance sheets, which not only won't fix the balance sheet but ends up taking all that money out of circulation in the greater economy, furthering the recession.
Worst, Obama and his team don't have a clear idea about what to do. They've committed some money to foreclosures, and that will help banks (less foreclosures means they lose less money and can value the worthless mortgage-backed securities), but it's not a comprehensive solution. There's the idea of taking all the bad assets away from the balance sheets (creating a "bad bank" of toxic waste, basically), but if that's done with no pain for shareholders, it's just as much a giveaway as Emperor Paulson's TARP program. Today at his confirmation hearing, which dealt far more with oversights on Timothy Geithner's taxes than the systemic meltdown of the US banking system, the Treasury Secretary-designate offered some words that presaged strong action.
Timothy F. Geithner, President Obama's nominee to be secretary of the Treasury, said today that the economic bailout program crafted by the Bush administration "needs serious reform," and that the riskiest course of action moving forward would be to spend too little and move too slowly in expanding the country's economic rescue efforts.
"The tragic history of financial crises is a history of failures by governments to act with the speed and force commensurate with the severity of the crisis," said Geithner, who as New York Federal Reserve president was intimately involved in the Bush effort and as part of Obama's economic team would be trying to push through Congress the massive stimulus package the president has proposed.
"If our policy response is tentative and incrementalist . . . then we risk greater damage to living standards, to the economy's productive potential, and to the fabric of our financial system. . . . In a crisis of this magnitude, the most prudent course is the most forceful course."
Well, the strongest action would be nationalization. And there's been a good debate among econo-bloggers over the last couple days, one I hope continues. Steven Waldman offers the precis of this debate:
The reason to nationalize a bank is because the bank has failed and its former owners have no legitimate claim to its assets. The government has been forced to offer support with public money, thereby purchasing the corpse fair and square. We take the bank into public ownership because taxpayers who have been conscripted to accept extraordinary losses are entitled to whatever gains follow the reorganization they finance.
When a bank is nationalized, shareholder equity should be written to zero, and existing management should be handled as roughly as the law allows. If we have a bit of courage, we should impose haircuts or debt-to-equity conversions on unsecured creditors, but I don't think we have that kind of courage. "Toxic" assets should be revalued at pennies-on-the-dollar market bids or else written to zero and hived into "bad banks". Once we have a conservative valuation of the assets and know exactly what is owed, we'll know how much public money would be required to cobble a robustly funded bank from the wreckage. However, if we recapitalize "too big to fail" banks without restructuring them, we will quite deserve our next mugging. We had better cut these monsters into little, itty, bitty pieces. We should embed strict size and leverage limits into their itty, bitty charters, restrict their ability to recombine, and then hire management to run the little things on strictly commercial terms. Hopefully we will change what it means for a bank to run on commercial terms — We should create a tax and regulatory structure that penalizes scale and leverage across the board. Better yet we should decouple the payment system from risk investment by reorganizing banking functions into "narrow banks" and credibly not-guaranteed investment vehicles. But whatever the banking industry comes to look like, nationalized banks should be recapitalized once, then managed to compete in it, and for no other purpose.
Basically, the investors of the banks, in this case the taxpayers, have every right to expect a piece of ownership. That doesn't mean America takes a nationwide poll every day on who to lend to, but it does mean that banks that rely solely on government support to survive ought to be treated as government entities, and the owners of government, the taxpayers, should reap the eventual rewards. Otherwise we're just funneling money to shareholders, helping exactly no one. Felix Salmon has more.