There comes a time in every economic crisis or, more specifically, in every struggle to recover from a crisis, when someone steps up to the podium to promise the policies that – they say – will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains.
Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble? The form of these vested interests, of course, varies substantially across situations, but they are always still strong, despite the downward spiral which they did so much to bring about. And fully escaping the grip of crisis really means breaking their power.
Not only is this a standard way of thinking about crisis resolution in many developing and post-communist countries, it also turns out to be a good guide to thinking about the US today. We have a powerful banking industry that has mismanaged its way into deep trouble. Yet these banks obtained an initial bailout – the Troubled Asset Relief Program, or TARP – on generous terms, and have consistently failed to use the opportunity provided by this government support to turn their operations around. Not only that, but they have flaunted their power – and their arrogance – through paying themselves large and largely inappropriate bonuses.
We come now, this week, to the podium. And Treasury Secretary Tim Geithner takes the stand (on Tuesday), to tell us how he proposes to use the remainder of the TARP funds, support from the Federal Reserve, and other policies to turn around the financial system and pull us out of recession. We previously posed relevant technical questions for this week; answers (or lack of answers) to these should determine if Geithner’s approach is likely to succeed. Think of that as a framework for reasonable technocratic assessment. But there is also the key political dimension to emphasize.
The elites who run the US banking industry have had a great run of economic good fortune. They used this wealth to further strengthen their political power, both through donations to politicians of almost all stripes and more broadly through taking positions of formal and informal influence throughout the executive and legislative branches.
Our unsustainable debt-fuelled boom, in other words, produced both the conditions for a major global financial disaster, and a political strengthening of the people who benefited most from the risk-taking and associated compensation packages that made this disaster possible. Ending the financial crisis is relatively straightforward – a forced recapitalization and change of ownership/management in the banking system – although this will not immediately lead to an economic recovery (more on that here). But seen in deeper political terms, decisive action to restructure large banks is almost impossible.  Such action would require overcoming perhaps the single strongest interest group in the United States today.
How can you do it? The answer must be by splitting this powerful interest group into competing factions, and taking them on one by one. Can this be done? Definitely, yes.  In particular, bank recapitalization – if implemented right – can use private equity interests against the powerful large bank insiders. Then you need to force the new private equity owners of banks to break them up so they are no longer too big to fail. And then… there is always more to do to contain the power of a lobby that is boosted by any boom and which, the more it succeeds, the more likely it is to ruin us all.
(Note: this is also a guest post at http://www.growthcommissionblog.org/; if you’d like the World Bank potentially to take note of your comments, please post there as well as here.)
The Baseline Scenario 
I have just recently started following your website and I thank you for sharing your insights. I am a retired attorney (5 years) and feel like I am a new student in your class. I also supported Obama in his campaign and hope that he is able to walk the walk like he talked in his campaign. I would sugest the gov’t create a new good bank that would be capitalized with a grant equaling the amount of the TARP gift already given to Citi et.al. plus a public offering raising a similar amount from private investors. The private investors would have a right to take out the gov’t at cost plus interest. Then see what happens.
I hope that you’re correct. I see anything short of nationalizing a few banks, and that threat hanging over them, as in Sweden, as a victory for them. They essentially believe, correctly as it happens, that they have purchased an insurance policy through lobbying, which goes into effect should a financial crisis occur. Not only the banks, but investors believe that this policy is in place. Sadly, when in comes to a Calling Run, only the government has the resources to stop it. Nothing short of government intervention is believable. So, in this case, we were pretty much stuck.
A new arrangement is possible, but only if the moral hazard which bankers fear is applied. They fear nationalization, which is why it is the one policy that has been ruled out. Ruling it in will signal that we no longer take orders from them. By the way, once we take them over, I won’t be happy until we’re rid of them. I believe that my way is both cheaper and quicker. Had we done this is October, so much could have been different.How sad.
Simon’s post is clearly descriptive of the “hope trade”. This is simply somewhat blind trust that all will turn out fine if one holds on to the bad trades as long as possible, figuring that the tide will turn before all capital is lost. With some experience observing such trades (albeit on minor scale compared to this situation), I would offer that the only remedy is coercion….a forced stop loss. The political power of the bankers (oh, and is the head of the NY Fed part of the deal?) makes the situation dire. I suspect that the public rage when it learns that the banks need another $1-2T has the chance of tipping the scales to the point where there those sitting on trades “marked to hope” may actually become ready to seek help that can become actionable. If they really come to realize that they may have to hit the bid (at 70% or worse) of carrying values, the opportunity could exist for them to see that the only way to survive is to unload the paper into the “bad bank”. I remain the skeptic, because it seems to me that we as a society have already concluded that most of these institutions are to big to fail….and I believe that Treasury, now as in the olden days of Mr. Paulson, is also trying to save businesses that are already in de facto default. The moment of moral hazard is now.
With some risk of making a trading judgement, I’d suggest getting short.
DB
Christine Lagarde, finance minister of France, was talking on Fareed Zakaria’s CNN show GPS on Sunday about how they had fired all the management of one of their banks. Zakaria thought this idea had some merit. What do you think?
Here is the transcript.
ZAKARIA: Let’s talk for a moment about the bank rescues — the one you did in France. You fired the top management in 48 hours.
LAGARDE: Two days.
ZAKARIA: Two days.
LAGARDE: Yes. We only rescued one bank. The other banks are solid and fine. That one was a Belgium-Luxembourg-French bank, and wrong business model, wrong management, wrong approach.
We injected capital, took over, fired the management, asked the new strategy and stopped loss — moved in place to stop loss guarantee. But we took immediate and decisive action, and we told the management to just get out.
ZAKARIA: When you saw the news that American banks had paid $18.5 billion in bonuses, did you share President Obama’s feeling that this was shameful?
LAGARDE: I was appalled. I was appalled.
And frankly, I have a proposal, actually, that those people who have had the benefit of years where they operated in a strange fashion, to say the least, now, why don’t they just volunteer a bit of their brainpower, a bit of their skills — and I’m thinking of a few individuals in particular who have been kept out of the system now — but they’re certainly unemployed.
(LAUGHTER)
And I’m not proposing to pay them any salary. But if they can volunteer their brainpower and their skills to help us, and their friends in the community, and all of us, a system that will avoid the pitfalls and the wrong incentive systems that have been in place, I think that would do some good to the community. Just like the hackers were hired by computers company, just in the same way we can take those guys and use their skills.
(LAUGHTER)
(APPLAUSE)
ZAKARIA: So, for any laid-off investment banker watching this show, please remember…
(LAUGHTER)
… apply to Christine Lagarde for a job.
LAGARDE: Low-paid.
While I agree with your post, my sense of the political situation is that the fact that Geithner is making the announcement Tuesday, a mere 21 days into the new Presidential administration, means that this is likely not the final showdown with the financial oligarchy.
However, with the inclusion of private equity into the mix, it is likely a stronger step than previously expected, and hopefully will demonstrate to the oligarchs that they will now have a much more serious fight on their hands.
President Obama is out “in the heartland” and is hopefully taking the pulse of the people – which is pounding with rage.
The suggestion of executing the responsible banking executives that Jim Surowiecki makes in jest on “The Balance Sheet” is, unfortunately, not very far from the mood of many in the American public…particularly when one recalls that the Chinese executed a senior government official just last year for corruption in office.
I have to disagree with Don…I really don’t see how one might characterize Simon as being too hopeful…if anything I think that recently he’s been much harsher than he was at the end of last year…(minus his comments on the Citibank deal, of course!)
I think its fair to say–cut our losses but let’s be pragmatic here–is it more important to punish the handful of bankers that got us into this mess or to get our economy back on track?
Now onto Geithner who…”resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.” That was disappointing to read tonight in the NYT. Maybe you’re right, Don? :)
Yves Smith is less than happy about what she learned from the NYT about Geithner’s “plan”.
http://www.nakedcapitalism.com/2009/02/geithner-bank-bailout-plan-fiasco.html
Yves: “This is tantamount to using antibiotics to treat gangrene. You waste good medicine and the progression of the rot threatens to kill the patient.”
“Our unsustainable debt-fuelled boom, in other words, produced both the conditions for a major global financial disaster, and a political strengthening of the people who benefited most from the risk-taking and associated compensation packages that made this disaster possible.”
Interesting contrast to the President’s claim last night that it was over leveraged financial institutions that caused our problems…
The issue of how you break an entrenched elite is at the core of more and more analysis of our problems. It is clear that the constrains on doing what we need to do are much more “institutional” than “analytical.”
At first blush I liked the idea of using a private equity elite to break the banking elite, but… they are the same group. Private Equity is about leverage and the Big Banks supplied the leverage — so this part of the analysis falls apart.
My fear is that there is no alternative power base to offset the entrenched bankers.
I am REALLY REALLY uncomfortable with PE doing the cleaning up of the banking world. They are cut from the same cloth–with lots of inbreeding amongst the two groups.
It is ‘institutional’ and how do we break an Institution? Well…maybe they themselves do the hard work for us…and we pick up the pieces?
Geithner is part of the olygarchy.If you people cannot see that then we are doomed to slavery.
YOU CAN’T SERVE TWO GODS!
YOU WILL LOVE ONE AND HATE THE OTHER OR SERVE ONE AND DESPISE THE OTHER.
A HOUSE DIVIDED CAN NOT FUNCTION.
ONE NATION UNDER GOD? THEY STATED.
GET WITH THE PROGRAM.
FOR ALL THE PEOPLE, THAT IS BECAUSE IN THE END HE THAT IS,
IS RUNNING THIS SHOW.
I am starting to feel that those Powerbank Kingdoms are setting up the vast overpopulation of earth for self genocide because they all know that humankind can NOT do a thing about it. It is a done deal to save the earth, they think.
I used to think that Schumakers’ book: “Small Is Beautiful” was meant for fluke liberals and people that stayed on college campuses too long. But now I am starting to see some of the redeeming qualities of such an economic structure. Simon’s approach to economics could be called either “Back to the Future” or “Progressive Status Quoism.”
Simon Johnson’s commentary above and in Bill Moyer’s Journal show on 13 Feb, demonstrate again that the oligarchs, corporations and their lobbyists essentially run the US government. They need to be reigned in not subsidized.
The current financial crisis and its supposed correction indicate that Congress is thoroughly corrupted and permeated by “bribes” in the form of campaign contributions. It needs to be reformed, and/or the word BRIBERY needs a very strict re-interpretation by the Courts.
After a brilliant campaign, earning accolades from the electorate, Obama has already fallen victim to excessive outside influence, the very problem he promised to correct. His brand new administration is already permeated with lobbyists and transfers from the very banking industry which as caused the financial debacle.
Obama has allowed exceptions to hire people with huge conflicts of interest with the banking sector. That is unforgivable.
The entire banking “rescue” appears to be a complete farce at the expense of the nation.
The foxes are not just guarding the chicken house, they also dictate the menu and who will pay for it.
If Al Qaeda had the brains and means of bringing the US to its knees via economic warfare, they could not have done better than what the financial industry, the banks, and members of Congress under their thumbs have done. 9/11 was a tragedy with nearly 3000 dead.
The two wars started by Bush were insanity that cost over 4000 lives and endless treasure, all borrowed. But causing an economic crisis, dumping the US into a severe recession or depression, is infinitely more effective in weakening this country than any minor attack by terrorists.
The banks and financial sector have done more damage to this country than any attack by military means. They have undermined the nations confidence, its willingness and ability to reverse course in the near term.
After Pearl Harbor, the nation rallied. After 9/11 the country came together though it was deceived into embarking on the wrong course.
This financial and economic crisis has sapped its strength, and the oligarchs of the financial industry and the Congress under its influence have managed to wreck it nearly completely.
The solution: no bank is too big to fail. Break them up, close the weak ones and quit rewarding the people who were the cause of it.
Are the oligarchs criminally liable??
Obama seems to have set out on a corrective course that is a s bad as the Bush actions after 9/11.
Simon
Please lobby for a job with the Obama Administration. You should take over from Geithner.
“Mistakes were made”. For example, to conspire to target / solicit mortgages from foolish indigents in the “hood” so that the piles of the toxic junk collected could then be resold in traunches to trusting banks in other countries was so blatantly illegal that hundreds of heads can be caused to roll in the direction of Gotham City. But where is justice swift or even sure anymore?
I like all the outrage. I’m just wondering where it was a couple years ago, when everybody was making money hand over fist and getting “rich” (on paper). Just as evidenced by the Madoff fiasco, you all were very happy to turn a blind eye to the deep corruption in the system when it was benefiting you, and only “discover” it now that you’re getting back to the reality of being poor.
Nice! Rage on!
Let’s see what happens. Will the Govt have the resolve is the question.
This post reminded me of two items I had recently read which also discussed aspects of the same:
http://www.lewrockwell.com/reynolds/reynolds19.html
Timothy Geithner and the Ruling Class
http://www.bloomberg.com/apps/news?pid=20601088&sid=a8mdg7z0u7Dw&refer=home
U.S. Housing Slump Has ‘Just Begun,’ Says Forecaster Talbott
It’s not just Geithner vs the oligarchy, but the millions of sheep who are corraled by the right wingers into thinking they’re one of them. Why else would more than 58 million Americans vote for John McCain. To get us out of this mess, we need to make sure that all Americans know which side their bread is buttered on.
Mr. Torpey (16 Feb, 3:47PM):
It is well to ridicule those who voted for McCain, but electing Obama will make no difference, for he is as much an insider, a man of the entrenched and corrupt system, as McCain is, perhaps more so. After all, look where Obama learned his political craft – in arguably the most corrupt city and state in the United States, Chicago, IL. You know, a place where dead people and seven-year olds vote, where the governor sells to the highest bidder, and where the Daley machine has run our schools and other public institutions into the ground…
I hope I am wrong, but things will get considerably worse before they get any better, is the view here. If the crisis affects only the common man, and not the big shots, nothing will get done to change things. The elites have not yet suffered enough, hence the status quo will remain in place at least for now.
i wish it was structured like this: bloomberg for president, obama for vise president, and simon for treasury sec. enough of goldman “dogs” who will always
listen their owners. as simon said it was necessary to
break down the power of small group usually associated
with third world countries. we should probably learn from swedes not to put band aid over toxic, but to start business from scratch…much cheaper and more efficient. sad to see smart people standing on the side
while the states going under.
one more thing that simon didn’t touch. someone should stop rating agencies like moody, s&p, etc. to rate anything, since their mathematical corrupted models failed from the beginning, not to mention loser’s analysts from citi, bac, etc. we all remember how lehman or bear downgraded someone just before their collapse. if it’s not pathetic and tragic i don’t know what is.
I think a first step towards recovery is for the taxpayers to claw back the hundreds of billions paid in bonuses at Wall Street banks that are now receiving hundreds of billions from taxpayers.
This is not to quell populist anger, but is merely a matter of basic fairness. That it may mollify the public is a side effect.
The WS massive and egregious bonuses were premised on the notion that they were earned for brilliance and creativity. It turns out the WS wizards were not brilliant, nor creative, just incompetent, and hence unworthy of these astronomical sums. Normally, this would be just an issue of corporate governance, not an issue of the taxpayers, but in this case, it turns out that the losses are not just shareholders’ money, but taxpayers’ money that has been improperly advanced to these bankers.
In the financial crisis on 1991-1994 Finland did not nationalize any banks. The government created junk banks to mop up bad loans. Taxpayers paid 8% of GNP to banks and insurance companies as unemployment hit 16%. Swedish solution was half as expensive and much more moderate.
In Finland GINI index increased faster, economic inequalities grew. But the high-tech boom with NOKIA as the spear head revived Finnish economy.
For the USA there are no export driven fixes to wait. There is no sense to American taxpayers to offer and suffer as much as the Finnish ones did.