Yesterday, Tim Geithner stated clearly – and reassuringly – that the Obama Administration will present a comprehensive and detailed economic recovery plan within a few weeks.
We know this plan involves a large fiscal stimulus, and it is reasonably clear there will be around $100bn for housing refinance/mortgage mitigation (out of TARP II funding), and probably some other symbolically important pieces intended to help consumers directly.
The big question is: what will be done about the total mess that our banking system has become? On this key dimension, we know little about the Administration’s specific thinking, but we can already see with considerable clarity the constraints that will bind as their thinking becomes concrete policy proposals.
There are three major political constraints.
First, the Plan must be different in substance and perception from the Bush/Paulson efforts. This may seem obvious and easy, but if you think that toxic asset disposal is needed, then this has to be packaged and presented quite differently from any of the previous iterations.
Second, there has to be much more buy-in from Congress. Arguably, Mr Paulson’s greatest mistake was creating the impression in September that he was trying to steamroll through the original TARP. “Do this or the financial system will die on Monday,” is not a message that conveys the impression you actually know what is going on and how to deal with the situation.
Third, whatever happens, transparency and accountability will be not just watchwords, but also a key part of any reality that Congress will be willing to support.
Of course, there are also economic constraints that imply some fairly essential principles.
- Let no bank fail in a way that causes significant losses to creditors. You might think that the massive Fed support for the financial system, put in place since September, makes it safe to let a bank default on its obligations, and you might be right. But I strongly suggest that we not find out – the risks are far too great. Also, this would violate the first political constraint above – you don’t want to do anything that could become like the post-Lehman/AIG moment all over again.
- Get it right the first time. The flip-flop policies of the fall were quite damaging. This is not a time for incrementalism or figuring things out in small steps. Even if the markets are very difficult this week and next, the Administration needs time to work out all the details and build political support – this will take at least a few weeks, perhaps even a month.
- The scale needs to be massive. A key principle of any macro stabilizing program is that it needs to be larger than the consensus suggests at the moment of announcement. Right now, people are talking in terms of $1trn-$2trn, but the numbers are rising by the day. The headline scale will depend on how long it takes to put the program in place and what happens in the meantime, but my sense is that we will be talking about sums in the $5trn range, or perhaps even close to 50 percent of GDP. (Note: this is not the expected final losses or how the Congressional Budget Office will score the program; that should be significantly lower, but of course it’s unknowable as it depends on the full set of US and global macroeconomic outcomes).
- Large parts of the banking system need capital. Private equity is available and interested, but it will hang back until it sees greater clarity on (a) the bank program and (b) the macroeconomy. The trick is to convince the leadership of this industry that the turnaround is just about to happen, and then they will pile in.
- We need a banking system, moving forward, that is free of the uncertainty overhang caused by bad assets. So the program needs to include a large degree of balance sheet clean up. There is a menu of established choices here, and any of these would work if scaled up sufficiently – this will probably be the biggest financial sanitation project the world has ever seen. But the political constraints will bind here – the central question is simply: what will Congress support?
- In the clean up, the valuation of bad assets taken or purchased from banks will be key. The essential principle here is: we will not overpay. But, of course, there are many devils in the details of how to establish that you are not overpaying. If you have good ideas on this, post them here; we’ve posted our suggestions, but no one yet has an ideal scheme.
President Obama obviously has to do more than a great sales job to get popular and congressional support; it requires persuasion of historic proportions. There is no doubt that he can do this, but it will be easier if he can propose:
1. A new structure, run by unimpeachable characters, with more transparency than you have ever seen in a public or private body. Let CSPAN cover every deliberation of this aggregator bank/RTC-type organization/control board in mind-numbing detail. Let everyone in on the complexity.
2. Not to nationalize the banking system. There would be a backlash against the idea that the US government can or should run the banking system. Also, can you imagine the explosion in lobbying activity and politically directed credit? The government needs to take the leadership role and commit capital (there is no one else available), but it also needs to get out. (One proposal is here; you can do this other ways).
3. Taxpayer value is of the essence. If you try to make sustaining jobs – either in banking or among borrowers – the key priority of the bank restructuring, things will go badly wrong. We need a cleaner, restructured banking system with new (private) owners and a complete change of management. A stronger banking system will support the change and growth in the US economy. The government, on behalf of the people who ultimately pay the nation’s debt, is willing to take on risk. But it must and will get a big chunk of the upside. Imagine the backlash if the banking system recovers through great government exertions and consequently we all have to pay the interest on additional government debt in the region of 20-30% of GDP, while a few relatively well-heeled individuals pocket massive fortunes.
And I would manage expectations very carefully. Cleaning up the banks, stimulating the economy through fiscal means, and reducing foreclosures are necessary but not sufficient for a return to sustained growth. They will likely give us a temporary boost, but we are in the midst of a big adjustment in the pattern of global savings – with almost everyone who is creditworthy around the world wanting to borrow less and strengthen their balance sheets. We need to ride through the ensuing storm, cushioning the blow for the weakest members of our society and the world.
We will get through this and, when we do, we’ll have stronger growth, with more opportunities for more people, if the credit system is healthier. But please do not form the impression that even the most comprehensive, carefully thought through, and brilliantly implemented plan will constitute any kind of magic bullet.