The President’s top political counselors face the following dilemma. They want to be tough on banks because that makes sense politically and, presumably, because it fits how they – with considerable relevant experience – would like to address the deeper underlying problems in the financial system.
But at least some prominent economic counselors to the President strongly disagree. The Treasury Secretary, in particular, articulates the view that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession. Mr Geithner wants to try other routes, and while he does not rule out imposing policies that banks would not like, it is not in his Plan A or likely a feature of his Plan B.
The President has evidently sided with Treasury, either because he decided they have superior technical competence, or because Emanuel and Axelrod themselves gave way when the experts stared them down.
The dilemma is this.
Should Emanuel and Axelrod continue to push hard for being tough on big banks, or should they throw in the towel for now and let Treasury run through its various schemes? To oppose Tim Geithner would divide the Administration and also seem strange – after all, presumably they were closely involved in his selection. But standing quietly by, say for two years, is not appealing if a critical part of our economic policies heads down a long blind alley. And as a midterm election strategy this would be questionable.
The presumption in this dilemma is that Treasury officials are the experts. But is that really the case?
As the President stressed Monday night, we face an impending financial system collapse of a kind not seen in the US in over 70 years. The situation, both technically and politically, is akin to what – over the past 25 years – we have seen frequently in emerging markets but seldom in more developed countries (with Sweden and Japan as notable exceptions.)
The world’s leading experts on such problems are for the most part not at the US Treasury, which is staffed primarily with people who have spent their careers working in (until now) relatively tranquil markets. Most of the relevant crisis resolution experience is to be found at the International Monetary Fund (IMF). The IMF is not comfortable giving advice to the Administration – the US is its largest shareholder and the Fund’s HQ is a few blocks from the White House for a reason – and IMF officials also cannot be called to testify before Congress. But the views of leading IMF banking crisis experts are freely available – off the record.
What they say is this. The right thing to do is reboot the financial system. Find out immediately which banks are insolvent, using market prices. Allow private owners to fully recapitalize, if they can. Have the FDIC take over all banks that cannot raise enough private capital. Try to re-privatize those banks quickly, while making sure the taxpayer has strong partcipation in the upside. The difficulty with this approach is not, in the US or elsewhere, anything technical – it is really quite straightforward. The problem here and everywhere else that has faced a serious financial crisis is: the power of the banking lobby.
If the IMF experts are right and Treasury is wrong, does that help resolve the dilemma?
The Baseline Scenario 
I have so much trouble integrating information coming from well thought out blogs – written by respectable economists like this one with the sentiment of the CNBC Fast Money crowd and the rising stock prices of banks like GS, MS, and JPM. If these banks don’t actually need more money (as their CEOs are claiming), and they are solvent, and they will eventually be able to make returns on some of these toxic assets (or hold them to maturity), then why do we need a bailout plan? Why not let those that can survive on their own survive and let all the others go bust and sell off their assets? Isn’t this market dislocation just a speedier way to get to what was bound to happen anyway – industry consolidation?
The US government can not do anything to these banks. It is the banks (investment and commercial) that work with the Fed to increase and decrease the money supply and regulate interest rates which impact the economy. The banks were only doing what the Fed and Congress wanted them to do. This is hypocritical for the US government to now blame the banks for the problem.
The answer to this dilemma is first architect a new system of banking and monetary policy, then create a pathway to get there, and finally execute it.
With the current bunch running the Fed, working in Treasury, and running the banks though, these people can’t be trusted to give us that new system. They’ve worked both in and out of government and are now vested to the same system they’d be asked to change.
Prof. Johnson:
Thank you for all of the excellent posts. Please keep it up.
My problem with waiting is that I am basically a follower of Fisher, and what I see looks a lot like a Debt-Deflation Spiral.If this happens, real unemployment could end up between 15 and 20 %. The social and political ramifications are quite scary, as they well should be if we have so much human misery. There is too much fear and aversion to risk tied up with these Toxic Assets, as well as uncertainty. It needs to be solved. Also, the idea of the government vastly overpaying and having huge losses going forward is being discounted by people who are assuming that, when the economy revives, no one will care. I do not believe that. This has been too traumatic to just forgive and forget. Call me a follower of Burke. I worry about social problems leading to unpleasant movements.
“The Treasury Secretary, in particular, articulates the view that being tough on the banks and top bankers would further worsen credit markets and thus deepen/prolong the recession.”
This sounds like our system needs bankers and shareholders more than taxpayers. In other words, for our cronysist welfare state, the loss of investor confidence from shareholders being wiped out is worse going forward than taxpayers being ripped off. I don’t think that’s going to be an acceptable narrative this time. Obviously many people disagree.
Frankly, calling TARP an attempt to preserve our free market traditions will do more harm to people’s confidence in the free market than nationalizing a few banks.
One final point. Compromise, in a crisis like this, is important. I don’t want to say that I find this plan impossible, and I do find a compromise understandable. But the same goes for the stimulus. Holding out because you claim some superior economic understanding is not advisable in a crisis. It is quite likely to lead to deep divisions that could be very hard to overcome should we really need consensus in the future. More Burke.
Why can’t members of the IMF be called to testify to Congress?
Also, don’t you undermine your nationalization argument by acknowledging that the Treasury Department is not staffed by experts in crisis management? Who is going to make the decisions about how to break up these large banks into the entities that are no longer too big to fail?
I believe Geithner may realize that as bad as the current management has been at running the banks, the government would be a whole lot worse.
I believe Geithner may realize that as bad as the current management has been at running the banks, the government would be a whole lot worse.
How is that possible? Additionally, the gov’t has a good track record of stepping into this sort of mess, fixing it and getting the banks back into private hands. The only thing standing in the way is what Obama calls our “culture” but is, in reality, the ruling social and political classes not wanting to take a hit. Our “culture” isn’t stupid and venal – it’s bamboozled.
Dr Johnson,
A couple of questions on your approach (that seems to be the consensus among academic economists and apparently the IMF) highlighted in other blogs:
1. Is there a fear that talking about nationalization will lead to a panic, including potentially a run on smaller banks that will freeze up the financial system?
2. Many, including the President, have argued that the size of US capital markets make it much harder to implement nationalization of insolvent banks a-la Sweden given the size/capacity of the US government.
3. It is reasonable to assume that some share of the toxic assets are currently underpriced, so the Geithner idea is to try and get the market for these assets going again by creating incentives for private investors to come in, buy the assets at what they value are more accurate prices. The result is, hopefully, that there are far few assets that are in fact toxic and thus need to purchased by the government (at the current market rates) and the banks get a better deal than currently, thus fewer of them are insolvent. Is this the premise of the Geithner plan?
4. Do you think that politically, the public is in favor of nationalization of large parts of the financial sector? Are there other options – i.e Chapter 11 with government debtor-in-possession financing.
Should Emanuel and Axelrod continue to push hard for being tough on big banks, or should they throw in the towel for now and let Treasury run through its various schemes?
One of the main criticisms of the Bush administration was that when the president was faced with a conflict between his advisers he basically defaulted and let whoever was stronger get their way.
One of the arguments for Obama’s presidency was that he would listen to conflicting advice and make his decision. So I don’t see division within the administration – especially over such a difficult subject – as a bad thing.
For the moment the president has made the decision to go with the advice of his Treasury Secretary. That wouldn’t be my decision, but he’s the president and if the policy fails it’s on his head. However Emmanual and Axelrod should continue to push – in private – for a different solution and hope that at some point the president changes his mind. If and when it comes to the point where they can no longer publically support the president they should resign.
Is it indisputable that the IMF experts are right?
The above article, and many others reference potential “impending financial system collapse.”
Could Baseline Scenario post (or someone point me to) a description of what that would look like…in a moderate and extreme form?
I need as simple explanation as possible. What, in specific and practical terms, would “economic collapse” look like in America?
(I’ve read the excellent ‘Crisis for Beginners’ piece and others and understand the leveraging issues. I just want to be able to better picture what a “total collapse” that people have in mind looks like.)
Thanks!
Axelrod and Emmanuel want to get tough on the banks. What exactly does that mean? What do these men understand about economics? finance? banking? They are left wing political operatives.
This looks like political grandstanding. They want to flog the villains who, they claim, brought this catastrophe on us. And then there are Bernanke and Geithner who seem to be in the bankers’ back pockets.
Do Axelrod and Emmanuel really want to get tough on the banks or do they want to distance from Tim Geithner so that they can saw off the diving board when he does things controversial. It was amazing to see Axelrod on the record in the NYT distancing from Geithner. Next Summers will be saying he disagrees with Geithner. Tim is on his own.
This is political cover. Obama, Axelrod and Rahminator could have been tough on the banks. They are trying to have it both ways.
After having watched the IMF over the years butcher countries so unfortunate enough to as to need to borrow money from them, I hope the President is not crazy enough to let them anywhere near the economy. Loan sharks, after all, only break your legs when you don’t pay back the loan, not when the money is being disbursed.
Geithner is making the same threats that Biddle made to Lincoln previous to the starting of the civil war.
Obviosly(civil war) lincoln had more balls than anyone in power today.
FDR said,
“in politics, if it happened you can bet it was planned that way”.
This says to me that we are being hustled big time and no one is willing to stand up and say it out loud.
the only solution is to take the printing of our currency back, and use a national fiat currency to replace the ever weakening Fed.dollar.It has been a very successful tool for combating the international banking cartels in America’s history
What is Israeli military personel Rahm Emmanuel(masaud) doing in the chief of staff position in the first place.I guess it’s the same as selling our ports to international corps.It all ads up to the end of America as we know it.Get ready for the Amero people.
On November 4th I voted and then rejoiced at the election of our President. The reasons for my rejoicing transcended politics, class, ideology and race. I remain hopeful but I cannot deny a growing feeling of unease and confusion. The majority of our country recognized the need for change. I now fear that we were too simplistic in our hopes and dreams. I fear our President has also overestimated the challenge and the adversaries of fundemental reformation of the critical institutions of our economy. The current crisis our Republic faces lays bear the powerful entrenched mechanisms and sturcture that has, for too long, made governing policy resemble lunacy and our fundemental rights are nullified. The Treasury Secretary will now have to demonstrate if he embraced his duties as an impartial regulator or is he in fact an enabler of the greatest Ponzi scheme in history.
Simon,
Do you think the administration is avoiding such a re-boot of the banking system for fear of inducing a run on the entire system?
In response to eRobin at 2/12 @ 7:57am:
Are you referring to the US government? Or other national government’s efforts when it comes to nationalizing banks?
There’s an article in today’s NYT’s which illustrates the difficulty the government is having managing the banks it has already taken over: http://www.nytimes.com/2009/02/14/business/economy/14assets.html?hp
In order to cope with the sudden increase in workload, the FDIC has a division whose budget has increased from $75 million last year to $1 billion this year. It’s calling up retirees and hiring contractors. They will do the best they can, I have no doubt. But I also know it will end up as a boondoogle. Taking over large institutions like Citibank, BofA and whoever else will be problematic.
Forgive my ignorance but I’m scared and looking for answers. I’ve come upon this site which seems to have thoughtful people with economics in their blood, so to speak.
Question: If these banks are nationalized (and from what limited knowledge I have, I’m leaning in that direction), who runs and manages the day to day operations? What happens to the Board of Directors?
Only when the banks became something other than banks did we all get in trouble.
Banks, at least my understanding of banks, is to take money, loan money, receive money in return for those loans. Investment funds have a different function and should remain separate from banks. Hedge funds by nature are totally too risky to be paired with a bank. Those walls should never have been removed. Now to fix this situation things should return to their intended function.
You have to trust all the people mentioned have respect for each other and their input in a strategy discussion. From what I have heard it really strikes a delicate balance. Geithner let it be known banks are not going to have such an easy ride this time to settle the public’s nerves, but at the same time tried not to spook the system. Forget Wall Street’s reaction as it is too easily manipulated and you have no idea who is pulling the strings to achieve an intended outcome.
What has happened to sweat equity? We run around like headless chickens at the thought of worthless fiat.If you want change,quit your job,grow your own food and school your kids at home.If that’s too hard,buy a new flatscreen.
Obama says it’s not in our culture to nationalize. However, he was elected to make the tough choices, and presumably he’s not beholden to the banking elite. It may be time to think of this as, “it’s not in our culture reject innovative thinking..” It seems that a lot of top economic thinkers advocate nationalization (obviously short-term, to be followed by privatization.) The “we’re all Swedes now” argument. Some fear that this will lead to a run on the banks. How likely is this? Are there real risks beyond damaging our own “cultural sensibilities?”
Why would you be so sure other than talk (which is about as cheap as some cdo’s) that Obama and his friends have anything other than well wishes for the banksters?
We’ll have to wait and see, won’t we? I, for one, have some optimism….I may be naive, but I don’t think we’ve been duped! It’s not all talk.
Don’t know about you, but my money is on the banking lobby; my price target on the SPX is 150.
Very nice site, by the way.
I believe that the comment by the following was the most insightful:
The Interest
12 Feb 09 at 1:09 am
Bottom line, this structure of money ultimately relies on central banking which is at the top of the banking pyramid. It is in with the government effectively creating a cartel. The IMF won’t fully critize this form of banking as they too will cut off their money center. I highly recommend this book called “The Case Against The Fed” which illustrates the current banking structure.
Click to access fed.pdf
Indeed, there is another way of banking; but it means the Government will lose its main source of spending power through inflation.
Passing out the coffers of the United States of America is the Emperor and Paulson providing all American’s with membership to the ‘GROUPTHINKTHINKTANK that (starting with saving AIG) the world will end as we know it if we don’t save the “toobigtofail” banks’ is the tailor in the story, THE EMPEROR HAS NO CLOTHES.