According to David Leonhardt, writing in today’s New York Times magazine,
TWO WEEKS AFTER THE ELECTION, Rahm Emanuel, Obama’s chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama’s top economic adviser, later described to me as Rahm’s Doctrine. “You never want a serious crisis to go to waste,” Emanuel said. “What I mean by that is that it’s an opportunity to do things you could not do before.” (Links in the quote are from the on-line original.)
Leonhardt explains how this Doctrine can be applied to issues ranging from health care costs to education, and some of this is already apparent in the fiscal stimulus details currently before Congress.
Can the same approach also guide actions regarding our deeply broken and broke financial system? There are three possible answers.
1. No. If you support this view, you presumably think (a) there are no powerful vested interests on Wall Street, (b) these vested interests are not a first order reason why we are in so much trouble, (c) these same interests are doing a good job leading us towards economic recovery. My guess is that this is currently the view of only a small minority; perhaps it is limited just to people who received large TARP-funded bonuses.
2. Yes in principle, but the situation is now so dire that we really don’t have the opportunity. In this view, the Wall Street interests are a problem, but we need to get credit flowing again as fast as possible, and this requires being nice to banks and bankers. If you think that maintaining or increasing the amount of nominal credit in the economy is the number one issue (e.g., for February), then this view may have some validity. But if credit is falling in part because creditworthy people don’t want to borrow as much as before and because desired savings are increasing almost everywhere in the world, then the case is weaker. Most likely, we have some time to sort out the banking system properly.
3. Yes, but how? Members of the incoming Administration have spent years thinking ahead about controlling health care costs and reforming education; no one really anticipated there would be an opportunity – let alone a potential need – to restructure the financial industry. Perhaps we should leave this to G20 reregulation, meshing with the Dodd-Frank legislative agenda at the national level? This might be part of the answer, but it doesn’t seem to match other proactive uses of Rahm’s Doctrine or the scale of the financial catastrophe.
Recent prominent actions on Wall Street – excessive risk taking, pervasive mismanagement, failure to take responsibility, mind-boggling bonus behavior – all point to a deeper underlying problem: no real owners. Large banks operate on the fundamental principle that it is all, “other people’s money.”
So it has been and so it is – except now it is very much taxpayer money, from the Treasury and from the Fed, that keeps large banks alive. In essence, the government is already the primary provider of capital to this part of the banking industry, i.e., we are in some fundamental sense already the owners, and if we provide more capital or insure/purchase more bad assets then we really own the store. (If anyone from a large bank would like to do without taxpayer support at this stage, please step forward.)
What should we do with our ownership rights? We will, no doubt, attempt to exercise greater control over executive compensation and bonuses – and the industry, no doubt, will evade the spirit of these controls quite effectively. We might impose some other symbolic restraints over corporate jets and the like, but none of this will be meaningful.
The only real way to apply Rahm’s Doctrine is to break the overly powerful vested interests in this part of the economy, and that means to break up the banks. The government needs to sell its effective control rights over large banks to private investors – providing them with at least temporary permission to become concentrated owners. Antitrust provisions must ensure that the large banks are dismantled in this process. Whether the executives stay or go is a matter for the new owners to decide. (For an example of how to organize the technical details of acquiring and disposing of government ownership, see our previous suggestions; there are other ways to do this that would also be quite straightforward.)
One pushback response to this proposal is: it’s too different, too risky, and there’s a good reason we’ve never been able to do this before. Fortunately, we have a serious crisis and Rahm’s Doctrine is in effect. And, really, it’s just an application to the US context of what other well-run countries have done when faced by a collective breakdown of bank executive competence.
Progress on the healthcare and education fronts will take many years, and the right way to measure success may well prove controversial. Progress on banking can be swift and the relevant metrics are straightforward – are the big banks broken up and placed under new, more effective ownership? And does the taxpayer finally get some upside?
The Baseline Scenario 
I agree with your point, but not your solution. We need to nationalize some of these banks. Why? For moral hazard. The thing that bankers fear most, that gets them steamed, and causes them to hoard money, is fear of nationalization. Anything less than that they accept as the price of salvation. In fact, the banking lobby believes they have bought and paid for this salvation through lobbying. I believe, contrary to you, that they believe that, so far, they are winning, given how atrociously, corruptly, and incompetently, that they have behaved. They must believe they have divine help.
Amen,
Nationalizing and dismanatling is terrible but the least bad and most fair solution by far. The check that taxpayers write these banks cannot be blank. If anyone from the Obama adminstration reads this please please do whats right rather then whats expedient and thus don’t remove the last vestige of hope for genuine public interest being represented in politics.
Naomi Klein’s “The Shock Doctrine” all over again. Well it did bring the US into war with Iraq. More of the same, anybody?
The current debates surrounding the stimulus package should serve to warn us all on the dangers of misalligned incentives. Despite the mess thats been made from current management, private owners will be best motivated to grow a firm and maximize profits, a strategy more alligned with taxpayers than ever! Consider the politician from Minnesota who requested $6M for snow making equipment, or the politician from California who wanted money to build tennis courts, each with stimulus funds. Are these the people we want managing our stake in the financials?
I think that this post regarding Rahm’s Doctorine actually just dances around the issue. Every day in every news channel and every outlet the world is told over and over that the world is in an economic crisis and that we are in dire economic times. Of course, looking at the official statistics, one can not (and should not) dispute these statements. They are true.
So now the question is, what is causing all of this? Is it fundamentally the decision to let Lehman go and then Mr. Paulson telling anyone who would listen that we were about to go into the the greatest economic depression since the great depression? And then everyone repeating that mantra over and over again? Perhaps partially.
So, continuing on this thread for a second…every commentator talks about “getting the banks lending again.” Well guess what, this is silly. It is silly because even if you could compel every bank in the US to start giving away loans, what have you done? You’ve loaned money to people who are over-levered and every commentator says can’t pay it back because we’re in the worst economic crisis since the great depression! (a self fulfilling prophecy to some degree). Additionally, TARP was/is not intended for banks to lend, TARP was to help recapitalize the banks. And Banks don’t lend their TIER 1 CAPITAL!
One final thought (and thanks for hanging in there if anyone is still reading this) is that its not “just” the banks that we need to fix. Yes, these national commercial banks (the government sponsored Big 4 of JPMorgan, Wells, Bank of America, Citi) need a tremendous amount of capital to fix their balance sheets to get the regulators happy, but even if all of these banks tried to increase their lending back to 06 – 07 levels, we would still be woefully short of enough capital. Remember the shadow banking system (ie private buyers like CLOS)? Fundamentally, this is the liquidity problem that needs to be solved…who is going to hold all of this debt (and is partially why you’re seeing the secondary market price in unprecedented discounts, but that’s a story for a later comment).
This is what is holding back lending. Banks (appear) to be actually doing their job of underwriting to the risks that are everywhere you look (back to the scare everyone tactic that Paulson took back in September), but there is no one to buy those credits in the secondary market anymore…so the amount of capital required if the goal is to reinflate the asset bubble (which it appears that everyone wants since we keep benchmarking back to bubble levels) is EVEN GREATER THAN PEOPLE CAN IMAGINE if there are no private buyers who want to buy fresh new loans.
Sorry to ramble a little bit.
I’d like to register my vehement objection to your assumption that Larry Summers and Rahm Emanuel (not to mention our tax challenged Treasury Secretary Timothy Geithner) are any less likely to act in their own selfish interest than the thoroughly objectionable present managers of the bankrupt banks.
Your post assumes and suggests that its only the presence of the corrupt and powerful vested interests on Wall Street that have rigged the investment game, when that’s just utterly false. In a different industry but similar game, what exactly did Tom Daschle do to earn his millions as Chairman of InterMedia Partners? Not much of anything as best I can tell — I mean, the not-reported-as-taxable-income car and driver were used 80% of the time for personal use!
Or go back and look at what happened to Brooksley Born in 1997-98 when she tried to get approval for the CFTC to regulate certain derivatives. Some form of regulation was a great idea, but she was shot down by Greenspan, Robert Rubin and a powerful Treasury department figure who told her that her ideas could provoke a financial crisis. Who was that? Well, Larry Summers, that’s who. Given that history, why on earth do you assume that Larry Summers is going to do the right thing when using Rahm’s Doctrine?
Don’t believe me, please check out this URL:
See how easy it is to make an argument and post a reference? Ain’t the inter net great?
Well, yes.
Doesn’t it trouble you that not only are many of the same executives who got us into this mess still managing their banks and financial institutions, but also that so many of the government enablers of the regulatory debacle (Summers, Bernanke, Geithner) are also maintaining their grip on power?
Just to cite one specific example, there were rumors in late Feb and early Mar 2008 that Bear Stearns had serious liquidity problems. This article from Vanity Fair gives a wonderful insider-view perspective:
http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808
Now apparently Bear Stearns’ liquidity problems weren’t massive though the whole mortgage market and B/D balance sheets were a bit frozen, so on Tuesday March 11th the Fed announced the “TSLF” to address the problem.
Now that did two things. The first tangible thing is that the Fed created a program to allow banks and B/Ds to exchange illiquid mortgage securities for highly liquid Treasuries, BUT the announced the program wouldn’t be implemented until March 27th. The second thing accomplished by the Fed announcement was to announce to the world that there was a serious liquidity problem in the markets, which caused investors to give all major financial institutions a quick once-over to see who might be in difficulty.
That Wednesday, I sent an email to a friend calling the TSLF “The Bear Stearns Bail Out Act of 2008”. What I didn’t realize quickly enough is that the Fed itself had sealed Bear Stearns’ fate: by creating the TSLF, the Fed had all but announced to the world that one-or-more major institutions could be having serious trouble, making the crisis worse, and by delaying implementation of the TSLF until approx. two weeks later on March 27th, the Fed guaranteed that extra liquidity to offset the panic wouldn’t be available soon enough to help. Under the circumstances, it’s not surprising that Bear Stearns pretty much went out of business on the evening of Friday March 14th. What is surprising is that Bernanke and Geithner are still viewed as being responsible people who are part of the solution rather than being part of the problem.
Let the normal bankruptcy laws apply to the banks. It’s called the market.
The problem with letting the normal bankruptcy laws apply to the banks is that when that process was tried with Lehman, the financial world pretty much came unglued within a week (go back and look – it was September 15th, 2008) and shortly after that the real economy started to fall apart.
My opinion: The chief transmission mechanism then was the nexus of the commercial paper market and Money Market Funds. Because Lehman went bust so fast and the Reserve Funds had way too much Lehman paper, the Principal Reserve MM Fund broke the buck spectacularly and froze investors’ funds on top of that. So there was a quiet run on non-Treasury MM funds that led to the commercial paper market freezing up.