Here’s a tough problem.
- The nation’s leading banks are short of capital, and only the government can provide the scale of resources needed to recapitalize, clean up balance sheets, and really get the credit system back into shape. Any sensible approach will put some trillions of taxpayer money at risk. We should get most of it back but – as we’ve learned – things can go wrong.
- Everyone hates bankers right now, and these feelings only deepen as we learn more about how the first part of the TARP was spent and mis-spent. No one wants to hear about anything that sounds like a bailout to bankers and their careers.
How does the Administration and Congress sort this one out? This weekend we seeing an approach take shape which, most likely, will work. There are five closely related moving pieces.
First, there will be an immediate clamp down on regulated banks and hedge funds. This will be popular. By itself, of course, it brings some dangers as pro-cyclical regulatory action is a good way to deepen a recession. But the goal here will be to flush out everyone and anyone who does not have enough capital to stay in business. This makes good economic sense and it will build support for the idea that this Administration can be tough on the financial sector while also turning it around.
Second, the fiscal stimulus will pass soon. This will be widely popular, particularly as there is something for almost everyone in the short run.
Third, some of the TARP II money will go into a program for refinancing housing. I expect this will run to $100bn+ (likely leveraged to a higher headline number) and will get broad support; who can really resist trying to break the death spiral of house prices, foreclosures and forced sales? Tim Geithner will probaby announce the broad contours within a day or two of being confirmed – in part because it also makes the point that the remaining $200bn or so in TARP II will not be enough to recapitalize and clean up the banking system properly.
Fourth, we will begin to understand that our intervention in the banking system is not nationalization but rather taxpayer participation in the upside gains from the impending recovery. Here is the right way to begin selling this,
“If we are going to put money into the banks, we certainly want equity for the American people,” said Pelosi, a California Democrat. “If we are strengthening them, then the American people should get some of the upside of that strengthening. Some people call that nationalization; I’m not talking about total ownership, but we’re just saying.” (From Bloomberg‘s coverage of the House Speaker on television today.)
Of course, we also need a technical solution for how the government gets in and then gets out of the banks, without becoming ensnared in a political and lobbyist quagmire. (We have proposals for this; so do others.)
Fifth, we need to have what Senator Kent Conrad emphasized today on CNN: “sufficient resources.” This is where the discussion only just begun (e.g., listen to some of Diane Rehm’s Thursday show) and where we will need to make rapid progress – probably just as soon as the fiscal stimulus is a done deal.
Did I miss anything?
The Baseline Scenario 
PRO-CYCLICAL REGULATORY ACTION
Sounds like your backtracking on this point.
There was great concern expressed a few months ago about the G20’s intent to take a fresh look at regulation of the finance industry.
Now that Obama wants to do this, it is acceptable.
Any reason for the change, or am I misinterpreting things?
The banks aren’t merely “short of capital”, they are insolvent.
If anyone has a good argument for why the shareholders of these losers should not be cleaned out first, and their creditors and executives and directors second — before taxpayers get stuck with the astonishingly-large bill — I would like to hear it.
I think the “technical solution” for the government returning banks to the private sector at a later date will be called a “sale.”
Citizens are angry not merely at the boondoggle of TARP, we are furious at the terrible inequity in the distribution of wealth, sponsored by double-dealing plutocrats, which is now finally tearing our society apart. In America, it seems, rip-off is truth.
I think we will know how this will really play out once Obama’s Attorney General is in place. The economic/financial reality is more bailout is required. The political reality is you can only do that by first demonstrating some ‘justice’ by frog-marching lots and lots of people. The frog-marching will also shut the Republicans up for fear they will be next.
I prefer to put my money for retirement in a church than in a bank. However, the reality of the system says that the banks will be the place to go to put our money. I don’t want to see rich people managing them. I want to see people from the middle class, the mainstream running the banks.
This sounds and looks great on paper, but the questions that are not being answered and what’s lost in this whole piece; How is credit going to begin flowing again and if the government is going to shore up the banks with the TARP program, the value of these toxic assets are still undetermined.
“who can really resist trying to break the death spiral of house prices, foreclosures and forced sales”
Well, let’s see. By 2004 it was obvious that we were in a housing bubble, so I delayed buying and carefully saved my money.
How is my responsible saving being rewarded? By having my wealth confiscated and given to bankers, speculators, and all the greedy people who bought houses they could never afford. The more irresponsible they were, the more of my money they get.
Personally, I would like to see house prices fall further; the more, the better. That is what you always want when you have saved responsibly instead of maxing out your credit cards and HELOCs to buy toys. But wow, was that ever a mistake. What the heck was I thinking?
Which banks, if you look hard enough, actually have enough capital these days? What happens if you try to flush out those who don’t have enough capital, and find that you’re left with nothing? And anyway, does the government even have enough financial muscle to hold together the crumbling pieces? The government may be able to print an unlimited amount of money, but it doesn’t have an unlimited amount of credibility. Putting a one-way bet on the government’s credibility does not seem like a smart thing to do.
Another analyst talks about an aggregator bank buying toxic assets while delaying determination of the ultimate price payed for the assets: http://www.breakingviews.com/2009/01/23/Bad%20bank.aspx?sg=nytimes.
Most of what’s being devised right now seems intent on avoiding some cold hard economic facts. The less that shareholders and bondholders have to pay the more the taxpayer has to pay. Let’s stop the intellectual sumersaults and just nationalize the banks and wipe the shareholders and bondholders out. At least two Nobel Laureates have now spoken out in favor of this, Paul Krugman and Joseph Stiglitz:
“A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to a special institution, the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.”
“What’s the alternative? Sweden (and several other countries) have shown that there is an alternative — the government takes over those banks that cannot assemble enough capital through private sources to survive without government assistance. It is standard practice to shut down banks failing to meet basic requirements on capital, but we almost certainly have been too gentle in enforcing these requirements. (There has been too little transparency in this and every other aspect of government intervention in the financial system.) To be sure, shareholders and bondholders will lose out, but their gains under the current regime come at the expense of taxpayers. In the good years, they were rewarded for their risk taking. Ownership cannot be a one-sided bet.”
http://www.cnn.com/2009/POLITICS/01/26/stiglitz.finance.crisis/index.html
Secondly, why are we even discussing foreclosure relief? This is simply an exercise in price control (not to mention the huge moral hazard problem involved). Housing prices are still 30% above their real average from 1890 through 1997. Trying to prevent them from falling to their fair market value is like trying to repeal the law of gravity.
Simon:
Love how you say “Obama” like it ends in an ‘r’ — “Obamer”.
There is no shortage of credit. The banks are falling all over themselves to lend me money. There is a shortage of creditworthy borrowers.
The economy as a whole is massively over-leveraged. Debt must be converted into equity. This applies to banks and borrowers. Banks which are under-capitalized should be required to sell equity at whatever price is required to do the job. If they can’t,they should be seized and have their unsecured debt converted into equity. As far as Main Street is concerned, many non-financial corporations are over-leveraged. This is why businesses can’t borrow at a reasonable cost. Consumer spending needs to fall until consumer savings recover to adequate levels to support retirement. Finally, government spending – in the long term – must be reduced.
Quick and decisive action by the government can restore health to the financial sector. But the adjustments to consumer/government spending that are required will take years. The only government stimulus that helps is income support for people in dire need and spending on one-time projects that truly need to be done and employ idle resources.
Instead the government sector is gearing up for a massive permanent expansion, feeble banks are being kept alive, lenders are being pressured to make unsound loans, there is an attempt to sustain the still-inflated prices of houses. The stage is being set for long-term decline in the American economy.