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?