Low Stress

Like Kevin Drum, I'm really trying to figure out what the hell this NYT article means.

For the last eight weeks, nearly 200 federal examiners have labored inside some of the nation’s biggest banks to determine how those institutions would hold up if the recession deepened.

What they are discovering may come as a relief to both the financial industry and the public: the banking industry, broadly speaking, seems to be in better shape than many people think, officials involved in the examinations say.

That is the good news. The bad news is that many of the largest American lenders, despite all those bailouts, probably need to be bailed out again, either by private investors or, more likely, the federal government. After receiving many millions, and in some cases, many billions of taxpayer dollars, banks still need more capital, these officials say.

....Regulators say all 19 banks undergoing the exams will pass them. Indeed, they say this is a test that a bank simply will not fail: if the examiners determine that a bank needs “exceptional assistance,” the government, that is, taxpayers, will provide it.

....Regulators recognize that for the tests to be credible, not all of the banks can be winners. And it is becoming increasingly clear, industry insiders say, that the government will use its findings to press certain banks to sell troubled assets. The hope is that by cleansing their balance sheets, banks will be able to lure private capital, stabilizing the entire industry.

If a bank needs "exceptional assistance," they either haven't passed the stress test, or the test isn't stringent enough to account for that possibility. If the banks need to be bailed out again, then they too have not passed the stress test, designed to see, as far as I can tell, that banks can survive on their own. In other words, the stress test isn't a stress test at all but a check of how much more money will need to be plowed into the system.

Here's Kevin:

So what have we learned here? First: all 19 banks will pass. Second: not all the banks can be winners. Third: the ones that pass — but aren't winners! — will be propped up by taxpayers. Fourth: no, they won't be propped up by taxpayers, they'll be forced to sell assets and raise private capital.

Huh? Which is it? If by "pass," regulators merely mean that a bank won't be instantly seized and its management defenestrated, then I guess this makes sense. Awards for all! On the other hand, the prospect of a bank getting a "needs improvement" grade and then successfully selling a big stock issue to raise private capital is just fanciful. Even banks that pass with flying colors will have trouble doing that.

So what's going on here? Why are Treasury officials privately telling reporters that everyone is going to pass but that some banks will receive a pass-minus and may be required to do things that are almost certainly impossible? Are they just trying to lay the groundwork for failure and temporary nationalization later on? Or what?

Any leak at this stage would of course give the impression that everything is fine. Wouldn't want to roust the "animal spirits" and get everyone panicking again. But just that very fact points to the outsized influence of the financial industry in driving US policy. The financial sector is simply too big relative to the rest of the economy, and the consequences are immense.

But what caused the fall and rise of inequality? A lot of very high incomes, both in the pre-1930 world and now, have been in the finance sector. A recent paper by Phillipon and Reshef (cited today by Gillian Tett in the FT) traces the path of relative compensation in finance, and ties it to regulation and deregulation. Here’s the key figure:



OK, correlation does not imply causation yada yada. The move to regulate in the 1930s was part of a broader crackdown on rampant capitalism, and the deregulation since 1980s was similarly part of a broader phenomenon. But it’s a good bet that finance is a key part of the story of how we got to where we are.

Over the past couple weeks, as this argument has become more prominent, the pushback from the banks is that the "level-headed" people must rein in the impulses of the "pitchfork" crowd, because economic recovery depends on a healthy banking sector. In other words, the same economic terrorism argument ("Keep us fat and happy or we'll blow this economy to bits!"). Simon Johnson deconstructs this nonsense.

You might think the “anti-pitchfork” strategy might work, particularly as it has in the past (e.g., in the early Clinton years). The problem for this strategy now is not just the fragile state of banks - by itself this can be ignored for a long while through forbearance, behind a smokescreen of complicated schemes with confusing acronyms - but the ways in which the markets they created now operate [...]

The technocratic options are simple, (1) assume a better regulator, of a kind that has never existed on this face of this earth, (2) make banks smaller, less powerful, and much more boring.

In other words, a dash of new regulation and a solemn promise from the banksters never to break the economy again won't cut it anymore, as the system has grown too big and too destructive. What we need is a different conception of the system of providing capital, one balanced against the size of the industries they can support, which actually produce goods and create jobs.

I know that the teabaggers have their own TV network and have sucked up all the political oxygen with their series of demonstrations, but the New Way Forward events happening this weekend are important. Not because street actions are necessarily valuable in the 21st century, but because the organizers behind this effort have a clear message that pushes against the simple left-right lens and really seeks a reinvention of our economic realities. Here's how honorary co-chair Mike Lux describes the effort:

I agreed this week to become an honorary co-chair of A New Way Forward, a spontaneous grassroots movement that is reminding me of the early days of Moveon.org. This impressive group of passionate organizers got involved because they were listening to progressive economists and business leaders talk about alternatives to the Geithner plan on re-building the banking system, and they decided to get involved. Some of these organizers are old hands like Joe Trippi (who truly is an old hand -- I met Trippi when he was helping Walter Mondale in Iowa in 1983, and he already seemed like an old hand then) and Zephyr Teachout of Dean campaign fame, and some are relative youngsters like Tiffiniy Cheng.

I agreed to become a co-chair in part (of course) because I strongly support the principles for banking policy that they have laid out -- the same ones supported by all of the economists and economic policy thinkers I respect the most, people like Paul Krugman, Dean Baker, Joe Stiglitz, William Greider, Simon Johnson, Jamie Galbraith, Leo Hindery, and Rob Johnson. But I also agreed to help because the spontaneous passion and obvious organizing skill, completely unsupported with money or institutional DC help, reminded me of the early days of Moveon.org. Before there was ever the online organizational giant of Moveon.org, it was a simple internet petition written and put online in the living room of Wes Boyd and Joan Blades and forwarded to a few of their friends. Wes and Joan didn't know anything about how Washington D.C. works, or how a PAC operated, or how a poll was conducted. They didn't have any money or institutional support when they started, although a few of us in DC recognized their potential and lent a helping hand. All they had was their passion about an issue (in that case, the impeachment fight), and great instincts about online organizing.

Somehow I got listed among their supporters, and it's a pleasure to be put in the company with the others on the list. Ultimately what will be important is not this series of rallies but what they spark. However, it would be nice to see a good counterpoint to next week's nonsense, so please join the demonstration in your area.