Night of the Living Dead Banks
“The fact of life is that Treasury Secretary Timothy Geithner’s bank-bailout plan is a dud of serious proportions…. Those who favor nationalization—a chorus now of unexpected voices from James Baker to Lindsey Graham—may see the Geithner plan as simply a prelude to set the mood of the nation and Congress, and develop the evidence to support bank takeovers.”
We had to endure months of confused, halting, feckless fiddling under Henry Paulson while credit burned. Then Geithner laid an egg.
The mounting counterattack on President Barack Obama’s economic program turns on the point that he is responsible for the sharp drop in stock prices of the last six weeks or so. The Wall Street Journal editorial page makes the disingenuous case often. Rush Limbaugh thinks he’s struck gold with it. Jim Cramer, the instantaneously opinionated money manager as CNBC talk-show host, has now apparently also decided that President Obama is responsible for the poor market performance of the last month or so.
It is largely nonsense. This is Bush’s recession and no political dissimulation can change that simple and widely understood fact of life—confirmed by the high ratings for Obama in the latest surveys. Just last week, we found out just how deep the hole was dug in last year’s fourth quarter—while Bush was still president, in case the WSJ and Limbaugh forgot. Gross domestic product turned out to have fallen at an annual rate of more than 6 percent. That number stunned economists. But increasingly bad news has been coming in ever since Obama became president and has roiled the markets. This week we found out from the regular Federal Reserve survey that the poor economy has laid low every region of the country. The February unemployment rate was reported today to have risen to 8.1 percent as job losses run more than 600,000 a month. If the Wall Street Journal editorial page were forthright, it would perhaps write the truth, not pure fiction.
The Obama administration has contributed to the confusion, however, and this should also be addressed squarely. The fact of life is that Treasury Secretary Timothy Geithner’s bank-bailout plan is a dud of serious proportions. I was taken aback, almost breathlessly waiting for the promised plan as I watched him on TV three weeks ago. We had to endure months of confused, halting, feckless fiddling under Henry Paulson while credit burned. Then Geithner laid an egg.
Stock prices dropped even as the speech was being made. Some, including apparently President Obama, who may have been misled by his advisers, claimed that Wall Street wasn’t happy because the plan would not simply relieve them of their responsibility. That’s not the case. The plan turned out to be no plan.
It called for a stress test of assets of banks. But a stress test is inherently ambiguous, and can be interpreted any which way you like. It called for a public-private partnership to invest in mortgage-backed securities, which Geithner insisted will enable private markets to set prices on the bad assets of the banks. To the contrary, the federal government would subsidize private investments and still determine the price. We won’t know what this means until we know the terms of the subsidy. Then Geithner said the housing plan would be laid out in coming weeks—not days, but weeks.
You couldn’t help concluding that the Obama team, led or not by Geithner, has been afraid to bite the bullet. Perhaps there is infighting, perhaps a fear they’d never convince Congress or the American people to put up the money needed, though that is belied by the size of the stimulus. What we got, unfortunately, was a less-bad version of Henry Paulsonism. (Ironically, CNBC’s Cramer, on Channel 13 in New York, pronounced the Geithner plan a success and said the Street just didn’t understand it. I followed him on the program from a different location and stated the opposite and obvious.)
By contrast, with its sketchy financial plan, Obama and his team did very well with the stimulus. This was quite an achievement. Admittedly, the stimulus should be bigger, and there should be no tax cuts, or certainly a lot fewer. But it deserves an A- overall, and a full A for political achievements. In a matter of a couple of weeks, the $800 billion package passed a skeptical Congress, and it will significantly help the economy. Demand is being drained from our real marketplaces as consumers, fearful for their jobs and dealing with trillions of dollars of losses in stocks and house values, are in turn saving hundreds of billions of dollars they otherwise would have spent on goods and services. Government has to step into this breach or there will be no foreseeable bottom to the recession.
The housing plan, whose details were at last announced this week, has also been encouragingly to the point. It will enable millions of homeowners to refinance at lower rates and create incentives to encourage bankers to reduce mortgage payments. Again, it is not enough. But give it a B+.
The credit-system fix of Geithner, Lawrence Summers, and company—all Robert Rubin acolytes—deserves perhaps a C-, and that is generous. Chastened by the falling markets, the administration at last released details of its plan last week. It raised some hope, but it is not the plan the nation needs. The new stress tests retain the flaws that were apparent from the beginning. They will require the banks to estimate the value of their assets should the recession prove extremely bad. Then the Treasury will decide who needs capital and, some are deducing, who needs a takeover by the government—the rationale for nationalization.
But the results of the stress can—and will—be fudged. They require an estimate of assets' value that simply cannot be made objectively. Those who favor nationalization—a chorus of unexpected voices, from James Baker to Lindsey Graham—may see the Geithner plan as simply a prelude to set the mood of the nation and Congress, and develop the evidence to support bank takeovers. In fact, the stress test will merely be used to justify whatever policies the administration deems required and politically possible. It is a charade.
I was also surprised that the Obama team actually requires a stress test to make these assessments. Don’t they have the information they need? Geithner is not new to the issues. He was part of the Paulson team, as president of the New York Federal Reserve Bank. I had always feared Paulson acted on the basis of little information. Now there was disturbing confirmation.
The trouble is that every week we wait for a more serious plan to get banks to start lending again, the economy worsens because its lifeblood is loans to support business. Many experts estimate GDP will fall at an annual rate of 7 percent in the first half of the year. Unemployment could easily reach 10 percent by late 2009. This is dragging down stocks, which reinforces the pessimism. It is also further undermining the value of assets on banks' balance sheets. And on Friday morning we get the latest unemployment number.
Is Geithner up to revising the plan and coming on strong? He does not act alone. It is unlikely he has done anything Summers does not approve, or perhaps has not himself devised. But this is not the ideal team for the job. It requires serious government intervention, and they continue to talk of public-private partnerships to buy toxic assets, another half-step that will be a lucrative boon to hedge funds. They seem to think the most damaged banks can operate without a change in management.
But there is also this problem: There is no simple answer. What have become known as “zombie banks”—the walking dead—should be reorganized and shrunk considerably if they are indeed unsalvageable, and their assets sold off to pay their liabilities. The reason to do so is so that a lot of good money does not follow bad. But advocates imply this will solve the credit problem, and it will not. There is not even a widely recognized definition for bank insolvency, though you’ll read about it time and again as if economists actually agree as to what it means, or can readily and consensually determine how many zombie banks there are.
Many banks are suffering under the weight of assets that are irrationally oversold. It would be regrettably hasty to value these banks on the basis of what you could get by liquidating assets today. These securities markets need help badly—a floor under prices. Government insurance of the better—rather than the toxic assets—may well be a way to raise the capital of these banks and enable them to lend again. It is a less-expensive and far more workable version of a bad bank, which would buy up the toxic material only. As part of the conditions for receiving insurance, bank management should be replaced in a number of cases. Even if the current bankers don’t lie about their true condition, they will tend to cover up their errors, protect their cohorts, and insure their personal bonuses. Replacing management is an option the Obama administration will surely resist.
At this point, however, Obama, Congress, and, arguably, the rest of the commercial world must also decide what kinds of financial institutions make sense for a modern economy. Should commercial banks, whose source of money is federally insured savings, be allowed to make mortgage loans and then securitize and buy those assets for their own accounts? What a conflict of interest. Instead, should there be a plain-vanilla commercial bank that does only what banks were started to do: Take deposits and make business loans and mortgages? Perhaps these vanilla banks should indeed be run as regulated utilities whose profit motive is moderated.
Should investment banks be separated from commercial banks to do the financial world’s innovation and risk-taking but be placed under strict capital and disclosure regulations? Should insurance companies be allowed to make markets in derivatives and trade them as well, exploiting solid insurance businesses, without federal oversight?
A large-scale plan with clear objectives has so far eluded the administration and most of the public discourse. They are not thinking big. And they are wasting critical time. Every day now counts. The Obama administration is only six or seven weeks old. They deserve respite from harsh criticism. I think they have done remarkably well in some areas. And this, contrary to the right-wing pundits and shrill talking heads, is not an Obama market—it is a Bush market, whose aftereffects will be with us a long time. So far, the Republicans don’t have a single viable idea to manage crisis.
But the Obama team must also see the world clearly, free of previous conceptions. The banking system is at the top of the to-do list. There is no resting on the laurels of a stimulus plan, but there is no indication yet that the team, still apparently married to a loyalty to past structures and versions of free-market bromides, is aware their bailout plan is a failure.
Jeff Madrick is a contributor to the New York Review of Books and a former economics columnist for the New York Times. He is editor of Challenge Magazine, visiting professor of humanities at Cooper Union, and senior fellow at the New School's Schwartz Center for Economic Policy Analysis. He is the author of Taking America, The End of Affluence, and The Case for Big Government.